Public Policy Analysis & Opinion

On the road with Hamilton, Madison, and Jay

Legislators would do well to read "The Federalist Papers"

By Kevin P. Hennosy

'Tis the time of year when we all look for unique and memorable gifts.

Did you know, through the magic of the marketplace, the unabridged version of The Federalist Papers is available in audiobook format at a price less than that charged for 1.5 gallons of gas in the Midwest? Woohoo! Katie bar-the-door and break-out the bourbon!

A personal, mobile copy of the definitive documentary analysis of the Constitution provides countless elements of epistemological pleasure. Beyond the obvious entertainment value of such an audio showcase, the audiobook production of The Federalist Papers offers practical usage.

For example, the next time that bothersome in-law who wants to be your buddy insists on "taking a road trip" just connect the audio-player device of your choice to the AUX input of the car stereo. Treat him or her to 20 hours, 30 minutes and 40 odd seconds of Alexander Hamilton, James Madison and John Jay. Your travelling companion will take the Greyhound home—and you will travel in freedom and liberty.

In public life and private discord, the Federalist framers continue to provide for our needs—if we choose to learn from them.

All joking aside, The Federalist Papers remain instructive today because Hamilton, Madison and Jay wrote the essays to explain the proposed Constitution and advocate for New York's ratification of the document. The papers serve as a "booster shot" of American democracy, which battles the contagions of special interest and ignorance that challenge the healthy application of constitutional government.

New legislators

One may assume that, in the aftermath of last month's elections, a new cohort of state and federal officials will be using the holidays as a time to prepare for taking on the charge of public service. Included among these officials will be legislators and regulators whom the public will trust to write the laws and rules that govern the business of insurance.

When new legislators become besieged by special interests and party leaders proffering tired dogma based on a state prerogative in insurance regulation, they should take a minute to ask: "What would the Federalists do?" (And no, I do not mean "What would the Federalist Society do," because that Orwellian group argues for a return to the failed Articles of Confederation.)

The Federalist Papers arose at a time when insurance was only starting to fulfill its vital role in the American economy. Most insurance reached the public through partnerships called "Insurance Offices," which had changed little since the transformation of Lloyd's Coffeehouse into a center for risk transfer. Nevertheless, in the 1780s, state legislatures granted the vast majority of corporate charters in North America to three types of endeavors: toll roads, canals, and insurance companies. In each case, the legislatures took the then extreme step of creating an incorporated entity, shielded from general liability in the case of financial failure, to serve a public purpose—not merely to foster private profit.

Partnerships sufficed to serve the cause of private profit; states granted incorporation as a means to use private funds to serve the public good. The focus of insurance to serve the public good made it particularly well suited for the corporate form, which established insurance in the jurisdiction of the states.

When one reads or listens to The Federalist Papers, it is difficult not to be struck by the practical nature of the political theory and arguments that shape documents. We may look back over two-and-a-quarter centuries and see the compilation of formal political theory; however, the authors wrote the essays to run in newspapers. While the arguments sometimes cite classical philosophy and ancient history, the rhetoric sought to shape public opinion. The essays played a similar role that blog postings play in the political process today. The authors aimed to build the political support of New Yorkers to support ratification of the proposed constitution.

If we can put aside the mystically hallowed name, The Federalist Papers, the compilation is striking in its straightforward effort to fix what was broken. In essay after essay, the authors offer specific examples of how the Articles of Confederation failed to serve the American people. The compact of independent sovereign states failed to provide the power and means to serve the people's national interests. Compact federalism failed to make a nation of the American people.

What also strikes the 21st Century reader is just how far from the original meanings presented in The Federalist Papers today's political dogma has strayed. The concepts of state sovereignty, nullification of national laws, and states' rights have worked their way back into political discourse and policy development, but these failed concepts rest in the discarded Articles of Confederation—not the Constitution.

The Federalist Papers explain with practical examples the necessity of rejection of those failed concepts. The use of the artificial constructions contained in the Articles to restrain and divide the people's authority to make national law—sovereignty—undermined freedom. Constraining popular sovereignty within arbitrary lines on a map (usually drawn to serve the commercial interests of the British colonial system) invited political faction (special interest) and aristocratic patronage.

As the source of sovereignty, citizens hold rights. Government jurisdictions hold responsibilities delegated from the people through the Constitution. The Constitution recognizes that the power to make law—sovereignty—rests with the free people, not the states. The sovereign people of the United States, not the states, "ordained and established" the Constitution. The ratification process carefully avoided the state legislatures and executives by using conventions.

Furthermore, a federal constitution serves as a division of labor aimed at serving the public good. Through the Constitution, the sovereign people delegate the authority, to serve the general welfare, or national interest, to the national government while delegating authority to serve the particular, or local, interest to the several states.

The Federalist Papers clearly state that the Constitution provides the means to fulfill any and all responsibilities delegated to the national government. Contrary to the Articles of Confederation, the Constitution delegated authority to the federal government to tax, to raise a national army and to regulate "interstate commerce." In addition, the Constitution provided an "elastic clause" which provided any and all authority "necessary and proper" to carry out the responsibilities delegated to the national government.

The inability of the states to put aside parochial interests to establish national commerce provided a driving impetus to overthrow the Articles of Confederation. The Constitution places clear limitations on the states in the area of interstate commerce, including the prohibition on states issuing currency. To evade that prohibition indirectly, states chartered banks that could in turn issue scrip, or banknotes. State banks encouraged the formation of fire insurance and inland marine insurers to secure the material goods that served as collateral for loans to commercial customers.

In the decade before the Civil War, states began creating insurance departments. Contrary to the politically charged legend, the first regulators focused on the character of individuals who formed insurance companies, and not just on the financial solvency of the concern.

Insurance executives were of two minds about the creation of state regulatory agencies. Some resented the oversight; others worked to make sure that insurance regulators had the power to keep charters and certificates of authority out of the legislatures. Regulators too often saw their role as a representative of the regulated industry.

It would not be until the Civil War that the promise of American government would begin to grow into the pattern cut by The Federalist Papers. At that time, insurance experienced massive growth as well. After the Civil War, life insurers revved up marketing for the investment-oriented "deferred dividend policy," which produced vast capital resources for the carriers' investment portfolios. Fire insurers grew into regional powers through cartel agreements, which were not illegal.

As insurers grew in importance as measured by finance and geography, executives began to grow restless with the deference they owed to individual state jurisdictions. The New York Underwriters Association failed in an attempt to secure federal charter legislation for insurance, so they fell back on the Hamiltonian ideal of judicial review.

The association triggered a controversy over agent licensing for its General Counsel Col. Samuel Paul with the Commonwealth of Virginia in the hope of pressuring Congress into exerting authority over the interstate commerce of insurance. To the surprise of the plaintiffs, the Court ruled in the case of Paul v Virginia that insurance was a contract and not commerce; therefore, it was not interstate commerce.

Hamilton, Madison and Jay would have begged to differ, but the post-Civil War Supreme Court seemed intent on shifting issues to state jurisdiction as a means to create general legal frameworks to support White Supremacy in the South. Insurance became locked in state jurisdiction concurrent with such notorious decisions as the Slaughterhouse Cases. The Federalist Papers seemed to fade away.

Facing failure at the court, the fire insurance cartels worked with New York regulators to create a new organization aimed at "harmonizing" regulations: The National Convention of Insurance Commissioners, which became known as the National Association of Insurance Commissioners (NAIC).

In response to scandals, or general inability to secure fire insurance coverage, states began experimenting with making collusive activity by insurance carriers illegal—even before the federal Sherman Anti-Trust Act of 1890. The state antitrust laws failed. Litigation costs tested state budgets, and once a cartel was broken up, a new one was easily formed again. The Paul decision prohibited application of the federal antitrust act to the business of insurance.

States like Kansas and Missouri worked to develop regulatory frameworks that would wrest economic and political power away from the fire insurance cartels. This effort instituted price and policy (rate and form) regulation. The state reformers received political help from a newly formed association of fire insurance agents that would be known under series of names, but is now known as the Independent Insurance Agents and Brokers of America (IIABA).

The German American Insurance Company challenged these new state assertions of power to the Supreme Court, where it was disappointed. The Court seems to have dusted off The Federalist Papers, when Justice Field wrote the decision in German Alliance Insurance Co. v. Lewis, Kansas Insurance Commissioner. The Court opined that affirmative regulation by the states—still honoring the Paul decision—was constitutional because the necessity of spreading the risk across the broadest population imbued insurance with a public interest.

In order to evade this new brand of oversight, and state assertion of the power to tax, some factions of the insurance sector continued to seek a way around the Paul decision by establishing a weak federal overseer.

Under Woodrow Wilson, life insurers worked with the American Federation of Labor (AFL) to kill national health insurance. Life insurers saw individual health insurance policies as an inexpensive accoutrement to entice life insurance sales. AFL President Samuel Gompers wanted workers to look to unions for health insurance and disability benefits.

With the coming of what historians sometimes call "The First New Deal," insurance executives who wanted federal oversight seemed to get their wish under the Code Administration of the National Recovery Act (NRA). But the Supreme Court ruled that the public/private cartels established under the NRA were unconstitutional.

The Roosevelt Administration shifted focus from collaboration to antitrust oversight. Insurance became one of many targets for antitrust enforcement, which resulted in the Supreme Court overturning the Paul decision in US v. South-Eastern Underwriters Association. Justice Hugo Black opined that insurance was commerce, and interstate commerce, in a commodity called risk. The opinion appeared "below the fold" on the front page of the June 6, 1944 edition of The New York Times—early reports of the D-Day landings filled the space above the fold.

The state-based regulatory system lost its legal standing, so the Roosevelt Administration supported congressional efforts to negotiate a temporary "moratorium" on the application of the antitrust laws. The congressional leadership, and the administration, rejected calls to simply exempt insurance from federal law and let "competition" sort it out.

Since March 1945, insurance regulation has been shaped by the McCarran-Ferguson Act, which delegates authority to the states to tax and oversee insurance, to the extent that the business of insurance is regulated by state law.

This era of public regulation means state officials must continue to endeavor to interpret and execute the McCarran-Ferguson framework. Congress provides oversight as do the federal courts. The states do not always succeed.

When Arizona regulators approved the transfer of a company in the interest of the stockholders, the Supreme Court stayed the state's hand. Insurance concern focuses on the policyholder, not the investor.

In Securities and Exchange Commission v National Securities, the Court defined the limits and breadth of the contingent delegation of the authority from the Congress to the states. Justice Thurgood Marshall wrote: "The relationship between insurer and insured, the type of policy which could be issued, its reliability, interpretation, and enforcement—these were the core of the 'business of insurance.'"

"Orthodox McCarranism"

The new public servants who will take the oath of office early next year should understand that no matter what phrases get thrown around in testimony, insurance regulation is not a "state prerogative," and there is no such thing as states' rights. Federalism means constructing one nation out of the people of the United States, and not merely compiling a group of states—that latter approach is Anti-Federalism.

The jurisdiction over insurance rests with the states only to the extent that they use it. That jurisdiction is not limited to solvency oversight, although new legislators often hear that ruse. Regulation is aimed at assuring that state-formed corporations empowered to work together in ways forbidden to other businesses still serve the public good.

As you move forward with your public service, keep reading Rough Notes because we think big thoughts in these pages. Happy Holidays!

The author

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.