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If you are using default settings, arbitration kicks in after three years of major league service and free agency kicks in after six years of major league service. The player you have listed is shown as having three years of pro service, which is not the same thing. Pro service starts counting from when a player was drafted. Major league service only counts time spent in the majors.
Assuming that the player below has no years of major league service, the game is functioning by the books. The AI is maybe questionable for not demanding a better deal, but a player good enough to command that sort of salary shouldn't normally be a free agent with no major league service time.
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