Public Policy Analysis & Opinion
Regulated cooperation and taxes
Let’s face facts when defending McCarran-Ferguson
By Kevin P. Hennosy
The insurance newswires have buzzed with trade association statements decrying congressional proposals to repeal the McCarran-Ferguson Act and defending the act with sophomoric arguments. As a commentator who believes in the McCarran-Ferguson Act, when I read these knowledgeable pronouncements from insurance leaders I have to ask: Do they really believe this stuff?
One statement after another ties together strings of keywords and catchphrases that communicate one clear message: Very few people in the insurance industry have even read the McCarran-Ferguson Act.
From the Wards of New Orleans to the hearing rooms of the U.S. Capitol, a consensus is building that the states are unable or unwilling to regulate insurance. Now, influential members of Congress have proposed a different kind of deregulation: recall the states’ borrowed authority to regulate insurance and in return apply federal antitrust law and Federal Trade Commission oversight.
When the National Conference of Insurance Legislators (NCOIL) convenes in Seattle, July 19-22, discussion regarding an effort in Congress to repeal the McCarran-Ferguson Act is likely to top the agenda. Over the past six months, NCOIL officers have conducted an intense lobbying effort in defense of the 62-year-old act.
The effort kicked off with the initiation of a study of state authority over insurance. The study will be conducted under the auspices of the NCOIL-sponsored/industry-funded Insurance Legislative Foundation. The Request for Proposal for the study included seven points that the final report should include:
1. The nature and history of regulation over the business of insurance
2. Laws, rules, and procedures that enumerate the jurisdictional responsibilities of officials in governing insurance policy and related consumer protections, including issues regarding the authority that may be due nonprofit corporations and similar entities
3. Case studies that help explain the evolution leading to the current insurance regulatory environment, including the growth of assets and of information utilization and security
4. The extent and effectiveness of intra-governmental communication and cooperation regarding insurance law
5. The impact that functional regulation, as established by the Gramm-Leach-Bliley Act (GLBA) of 1999, has had on insurance oversight and responsibility
6. The consequences of federal preemptive measures on insurance policymaking
7. The role that organizations such as NCOIL and other state legislative groups, the National Association of Insurance Commissioners (NAIC), the National Governors Association (NGA), and the National Association of Attorneys General (NAAG), among others, play in insurance public policy
The sudden and abiding interest in just what the McCarran-Ferguson Act means is in direct response to S. 618, The Insurance Industry Competition Act of 2007. The legislation is the most recent of a series of bills drafted in response to a spike in medical malpractice insurance rates in the early years of this decade. Senator Patrick Leahy (D-Vt.), who chairs the Senate Judiciary Committee, sponsored the bill, which has the support of the committee’s ranking Republican, Senator Arlen Specter (R-Pa.).
On June 20, 2006, during a hearing of the Judiciary Committee, Senator Leahy observed, “Among the 15 best-rated medical malpractice insurance providers, premiums rose dramatically between 2000 and 2005, while the cost of claims paid out remained flat. If claims are not driving premiums, but insurance costs among competing companies are rising in lockstep with each other, it is time to admit that there are other causes of this problem.”
Senator Leahy continued, “If insurers around the country are operating in an honest and appropriate way, they should not object to being answerable under the same federal antitrust laws as virtually all other businesses. American consumers, from sophisticated multi-national businesses to individuals shopping for personal insurance, have the right to be confident that the cost of their insurance reflects competitive market conditions, not collusive behavior.”
To a lesser but still material extent, congressional support for McCarran-Ferguson repeal has grown in response to reports of slow, incomplete and combative claims settlement practices following Hurricanes Katrina, Rita and Wilma. Take a trip to the devastated areas of the Gulf Coast, and you will hear a consensus opinion that there is no state insurance regulation.
One of those disgruntled Gulf Coast policyholders is U.S. Senator Trent Lott (R-Miss.), who has battled with his insurance company since losing a coastal home to Katrina. Lott, the Republican Whip, has expressed support for Senator Leahy’s repeal bill. He also supports the creation of a federal backstop for catastrophe losses.
In addition to trouble in Congress, the insurance sector received a body blow from a federal commission charged with conducting a review of antitrust oversight and enforcement. The Antitrust Modernization Commission reported to Congress and the President on April 2, 2007. The report called on the Congress to repeal the McCarran-Ferguson Act.
Taken together, the combination—the Democratic take-over of Congress, existing legislation with powerful bi-partisan support and a high-level commission report—presents a real threat to the state regulatory system. In addition, since it has been nearly 20 years since the last serious attempt by Congress to repeal McCarran-Ferguson Act, there are very few experienced people in the vaunted insurance lobby who have waged an effective defense of the act in the face of a hostile congressional leadership.
If the insurance sector and state regulators want to beat this challenge back, they will have to do so “on the merits.” To do that, a younger generation of executives, lobbyists and officials are going to have to learn what McCarran-Ferguson does and does not do. This should not be left to the ranks of public relations people who just write testimony, press statements and other documents that sound warm and fuzzy.
Since 1995, industry advocates, senior NAIC staff and many insurance commissioners have sung the praises of insurance deregulation. It did not matter that there was no provision for insurance deregulation—short of restoration of federal jurisdiction—in the McCarran-Ferguson Act. Executives, lobbyists and insurance commissioners who wanted to be executives and/or lobbyists, paraded around the country with the NAIC singing the praises of deregulation. The NAIC even passed a commercial lines model law that “assumes” competitive markets and places barriers before officials who want to hold hearings.
In the meantime, very bad things were happening. Reliance Insurance was raided by speculators. Med mal rates soared with no corresponding spike in claims. Insurance lobbyists were successful in getting laws passed to exclude mold, but for some reason premiums were never reduced to reflect the reduction in exposure. And let us not forget that while NAIC was recommending deregulation, major brokers were engaged in price-fixing, which was uncovered by an attorney general and not insurance regulators.
As insurance sector and insurance regulatory advocates move farther and farther away from a basic understanding of McCarran-Ferguson, the act is placed on more tenuous political ground. McCarran-Ferguson offers a strong but flexible framework, but policymakers and interest groups threaten to undermine that support—at their own peril.
If regulators and executives believe their own rhetoric, the McCarran-Ferguson Act is in real deep trouble. They should understand the act and defend it based on that understanding, but to date they seem to try to make the act all things to all people.
The most egregious violation of the historical record concerns statements that describe McCarran-Ferguson as a framework to foster “competition.” Perhaps this word sneaks in because it is used in the name of the senate bill. McCarran-Ferguson was a shield for anticompetitive behavior and not competition.
In 1945, if Congress wanted to foster competition in the insurance sector, it did not have to pass a law at all. The previous year, the Supreme Court ruled that the business of insurance was interstate commerce; therefore, insurance was subject to federal antitrust law and enforcement that fosters competition in almost every other commercial sector.
Congress did not have to create a special legal framework for insurance, if competition was its aim. Congress acted by passing the McCarran-Ferguson Act because policymakers believed that competition eroded the long-term viability of insurance. Where did congressional leaders, get this idea? They learned it from the insurance sector, of course—in reams and reams of testimony and reports. McCarran-Ferguson is anticompetitive by nature.
While anticompetitive grates on our ears six decades later, policymakers in 1945 believed that a certain amount of cooperative activity in product design and pricing served the public interest. The use of cooperatively designed forms made insurance more understandable, which could increase competition through comparative shopping. Cooperation in ratemaking was seen as vital at the time to building and maintaining adequate reserves, and it shielded insurers from price war competition.
Usually the need for cooperative action is explained in terms of small and regional companies that could not collect enough data to create a valid statistical sample to create rates or design forms. Nevertheless, there are many large companies that use the product of cooperative action, such as adopting forms or advisory rates created by the Insurance Services Office (ISO).
Insurance trade groups argue that the mere existence of 5,000 total companies or 2,000 property/casualty carriers in the insurance sector is proof of competition. This is a fallacy of logic. When many of those companies are related through holding company arrangements and others share interlocking board membership, competition is lacking. When large percentages of property/casualty insurers use ISO forms to shape their products, and another large proportion uses ISO advisory rates, and still others simply wait until a large national carrier files its rates and then set their own in “me too” fashion, this is not the picture of competition. When a handful of reinsurers can shut down entire lines of insurance, there is not effective competition. If the insurance sector tries to defend the status quo as competition, they will lose.
This is not to say that these anticompetitive behaviors do not serve the public interest; however, the industry should understand the strengths of the current system and argue for them.
In addition to the stated desire of protecting some forms of cartel-like behavior, the Congress had another reason why it did not need to act in 1945. When state officials act to regulate commercial activity in their jurisdiction, courts have ruled that the commercial activity is exempt from federal antitrust enforcement. This is referred to as the state action doctrine.
Under the state action doctrine the courts have imposed an “active supervision test” to discern whether or not the aims of antitrust law were being fulfilled by state regulatory frameworks. Today, insurance lobbyists fear the pure application of the state action doctrine to the insurance sector because they believe that it would result in more intrusive regulation by states.
From a historical perspective, the drafters of McCarran-Ferguson called for “affirmative regulation,” which for all intents and purposes would fulfill the active supervision test—but insurance advocates have traditionally tried to exaggerate the difference between the two. Rightly or wrongly, it can be convincingly argued that the McCarran-Ferguson framework calls for less regulation than the state action doctrine.
Leaders in Congress, the insurance sector and state regulation worked together to craft a system of public oversight separate from federal antitrust law but subject to public oversight. The McCarran-Ferguson Act lends the states its constitutional jurisdiction over a vital sector of interstate commerce known as the “business of insurance,” which the Supreme Court has defined in broad terms: “the relationship between insurer and insured.”
Congress did not simply rely on the state action doctrine because both congressional leaders and the Roosevelt Administration doubted that the states would act. Both groups recognized the bullying political power in the states, and it was assumed that state officials would simply allow the old cartel system to return. For that reason, congressional leaders and the administration created a bill that tied state action to something they knew that state officials wanted—tax money.
The legislation that resulted in Public Law 15 of 1945 carried the subheading “an act to regulate the business of insurance.” On constitutional grounds, Congress could not order the states to regulate insurance; however, Congress could make the alternative to state regulation so distasteful for insurers that the sector would work for state regulation. In addition, Congress offered the states an incentive to make the system work: unfettered authority to assess taxes on insurance premiums.
The states’ addiction to premium tax revenue provided strong incentive for legislatures to enact an insurance regulatory framework in the late 1940s. If state officials were not afraid to lose the ability to place a tax on insurance premiums, state insurance regulation would lose a lot of cheerleaders in state capitols. The taxes paid by the insurance sector buy a lot of lobbying power by state officials.
The states’ addiction to premium tax revenue is as strong or stronger today as it was in 1945. This is a dynamic that should make state officials very wary of cutting deals with Congress.
Of course, if state officials— many of whom are now ensconced in high-paying insurance sector jobs—had not gutted the states’ regulatory frameworks over the past 12 years, today’s state officials would have a better story to tell. As it stands, the NAIC and state regulators are better suited for offering apologies than mounting a defense. *
Kevin P. Hennosy is an insurance writer who specializes in the history and politics of insurance regulation. He began his insurance career in the regulatory compliance office of Nationwide Insurance Cos. and then served as public affairs manager for the National Association of Insurance Commissioners (NAIC). Since leaving the NAIC staff, he has written extensively on insurance regulation and testified before the NAIC as a consumer advocate. He is currently writing a history of insurance and its regulation in the United States and is an adjunct professor of political science at Avila University. Hennosy publishes a quarterly briefing paper on the activities of the NAIC, which is available at www.spreadtherisk.org.