Public Policy Analysis & Opinion

By Kevin P. Hennosy

PRETENSE OF REGULATION DISTURBS MARKET

COVID-I9 business closures trigger claims and conflict

As the COVID-19 pandemic swept across the country, civil authorities ordered people to stay in their homes; many businesses closed, and these enterprises suffered financial loss.

Some business owners are looking to their commercial property policies to recoup those losses under business interruption coverage. Old insurance books describe one of its uses as replacing lost business income if a city closes a sidewalk in front of a store.

Paying claims under the civil authorities business interruption provisions of commercial property policies could help the United States avoid a serious and lasting economic downturn.

On the microeconomic level, the proceeds from those claims could keep small businesses solvent and hasten recovery after the public health crisis passes.

[T]his year localities and states issued unambiguous orders … to cease operations, so a reasonable person can opine that … policyholders have a strong claim under the “civil authorities” provision … even if carriers try to employ the virus and bacteria exclusion.

On the macroeconomic level, the collective impact of compensating those businesses would be increased demand for supplies, and it would put money in the pockets of employees to recharge consumer demand.

In short, business interruption payments could inject Keynesian countercyclical purchasing power from the private sector into a damaged economy.

The U.S. Supreme Court referred to this same dynamic more than 20 years before Keynes, in German Alliance Ins. Co. v. Lewis, 233 U.S. 389 (1914). In that case, the court held that insurance served a public interest (beyond claimants and policyholders); therefore, it should be subject to public regulation.

Bad news

Or the insurance carriers can cavort before a golden image of Baal and really mess things up for the business of insurance, which is based on trust.

Agents, as representatives of insurers, have the unwelcome task of explaining business interruption provisions to their clients, given the exclusion for losses that result from viruses and bacteria.

In some quarters, business owners are blamed for “misunderstanding” what they bought. Who would assume that an insurance policy would provide financial benefits after a catastrophe?

In many cases, the virus did not directly trigger the loss. Instead, government orders forced the closure of some categories of small business, such as bars and restaurants. Other entities remained open but lost customers because of stay-at-home orders issued by civil authorities. Still, carriers deny claims.

Many observers believe carriers sought to insert exclusions in business interruption coverage after Hurricane Katrina in 2005. Overall, carriers avoided the full force of Katrina claims, which breached trust in insurance in the areas affected by the storm.

For example, because of a clumsily worded evacuation order issued by civil authorities, insurers denied claims by arguing that the order was not “mandatory.” Insurers denied water damage claims under the flood exclusion, even when evidence existed that the damage was not the result of a natural flood event. Some policyholders tendered claims based on contamination caused by bacteria and mold after the water receded, which likely led to policy changes.

In 2006 the Insurance Services Office (ISO) issued Circular letter [LI-CF-2006-175], which announced an exclusion in commercial property policies for business interruption losses arising from viruses and bacteria.

Throwing ISO under the bus seems habitual to some carrier executives. Blaming ISO is particularly effective because outside of the insurance sector, no one has heard of it. An acronym sounds so official, and if anyone asks what the acronym stands for, the words are so plain that they are almost boring … like some lesser bureau in the “Ministry of Love” in George Orwell’s dystopian masterpiece 1984.

ISO conducts the technical work to create policy forms and rates. In this endeavor, ISO engages in the technical activities that the Supreme Court used as a definition of “the business of insurance”—but more on that later.

State action

ISO is the last historically operative link to the grand system of legally approved cartels that governed fire insurance between the Civil War and World War II. This is not to allege that ISO is a cartel today, but it has residual power.

The cartels operated legally because the Supreme Court decision in Paul v. Virginia, 8 Wall. 168, 75 U. S. 183 (1869) held that insurance was a contract, not commerce; therefore, insurance was subject to state jurisdiction.

Insurers worked with New York political boss William M. Tweed to create what is now known as the National Association of Insurance Commissioners (NAIC) to tame state officials who might interfere with the cartel system.

In those days, stockholder-owned insurers relied on the regional cartels to design and price policies. In addition, the cartels castigated any agent who sold a policy for a non-cartel company. This anticompetitive activity remained legal even after Congress passed the Sherman Antitrust Act, the Federal Trade Commission Act, the Robinson-Patman Act, and other antitrust legislation and enforcement—until everything changed on June 5, 1944.

On that date, the Supreme Court ruled that insurance is interstate commerce when it granted standing for the Antitrust Division of the U.S. Department of Justice to bring a case against South-Eastern Underwriters Association (SEUA), a regional cartel.

In United States v. SEUA, 322 U. S. 533 (1944), Justice Hugo Black wrote for the majority and overturned Paul as precedent, saying insurance is a commercial transaction and further that it constitutes interstate commerce in risk.

The Constitution reserves jurisdiction over interstate commerce for Congress, not the several states. Still, Congress and the Roosevelt Administration deemed insurance too technical for consumers to make informed choices; therefore, the business of insurance was inappropriate for competitive markets and the antitrust laws that foster and police those markets.

After the SEUA decision, Congress passed the McCarran-Ferguson Act.

The law makes a limited and contingent delegation of jurisdiction over insurance to the several states, to the extent that state law regulates the business of insurance. In a signing statement, President Roosevelt expressed his belief that after a moratorium period the business of insurance would rise to federal jurisdiction.

In passing the McCarran-Ferguson Act, Congress did not provide the insurance sector the limited and contingent shield from federal antitrust law as a special-interest gift. (Consumer groups allege that corrupt transactions give away one of their greatest advantages—a federal law requiring regulation.)

Congress stayed antitrust laws to allow insurers to cooperate to provide consumers apples-to-apples choices at a fair price—if state action regulates that activity.

Early court interpretations of the statute found that states cannot transfer that loaned jurisdiction to private entities, nor may one state act on behalf of another state.

What activities must the several states regulate? Some argue that the states must merely concoct a “regulatory scheme” limited to solvency.

One can understand that breadth of activity by reading Supreme Court opinions with an historical perspective. In a clearly written opinion in Securities and Exchange Commission v. National Securities, Inc., 393 U.S. 453 (1969), the court offered a definition of the “business of insurance.”

The court reversed actions taken by the Arizona director of insurance to benefit shareholders, which the court found to be beyond the jurisdiction given to the states by McCarran-Ferguson. Justice Thurgood Marshal defined the business of insurance as: 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.”

Under federal statute, the states should act to regulate that “relationship between insurer and insured.”

Tweed lives

Of course, as this column noted in a recent issue, the business of commercial property and casualty insurance no longer benefits from state regulatory action. In the 21st century, most states adopted legislation based on the NAIC Property and Casualty Commercial Rate and Policy Form Model Law (MDL 777), which prohibits state action in commercial lines unless there is not a competitive market, and then presumes market competition, stating:

A competitive market is presumed to exist unless the commissioner, after hearing, determines that a reasonable degree of competition does not exist in the market and the commissioner issues a ruling to that effect.

NAIC corrupts the McCarran-Ferguson framework with a model law that recommends inaction, in contradiction to the federal statutory scheme. NAIC recommends a framework where assumed competition “regulates markets. ”In the absence of state action, private groups like ISO or large insurers create policy forms and prices, which translates to “rubber stamp.”

Any informed observer would see that argument as a “pretense of regulation,” which Justice William O. Douglas warned about almost 50 years ago. When the Supreme Court declined to “order up” the case of Ohio AFL-CIO, United Autoworkers of Ohio v. Insurance Rating Board, 409 U.S. 917 (1972), Justice Douglas wrote in dissent:

In Federal Trade Commission v. National Casualty Co., 357 U.S. 560, 563, 2 L. Ed. 2d 1540, after examining the statute and its legislative history, we held that federal regulation as to advertising practices was prohibited in those States which were regulating such practices under their own laws. We indicated, however, that the grant of exclusive regulatory power to the State would be ineffective if the state statutory provisions which purported to regulate were a ‘mere pretense’ of regulation.

Justice Douglas believed that the plaintiffs provided enough supporting evidence of a pretense of regulation that the court should have heard the case.

Unlike the case with Katrina, this year localities and states responded to the COVID-19 pandemic by issuing unambiguous orders to broad business categories to cease operations, so a reasonable person can opine that those policyholders have a strong claim under the “civil authorities” provision of business interruption coverage—even if carriers try to apply the virus and bacteria exclusion.

The carriers seem nervous about all those insured businesses that have been ordered to close. In March, David Sampson, president and chief executive officer of the American Property and Casualty Insurance Association (APCIA), estimated that the sector would pay $220 billion to $383 billion per month in business interruption claims.

Coverage denials triggered litigation.

What test?

The McCarran-Ferguson Act does not apply a test for a “reasonable degree of competition.” The statute requires regulation by state law, which encompasses the “relationship between insurer and insured.” A “pretense of regulation,” perpetrated with a rubber stamp applied to the proposals of private entities, does not seem to meet the historic meaning of the statute.

Failing that test, the statute automatically returns insurance to federal jurisdiction—complete with antitrust law, Federal Trade Commission enforcement, and treble damages from the courts.

In the absence of affirmative regulation by the states, who knows where litigation might lead?

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 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.