SPECIAL REPORT

INSURANCE CARTEL AND THE PRESENT TENSE

After six decades state officials blew it,
but federal oversight proposals offer little hope for improvement

By Kevin P. Hennosy

Regulation implications—Analysis & Opinion

State officials failed to do the job that Congress charged them to do in 1945 when the Congress directed the states to establish a regulatory framework that ended the old cartel system ... Nearly 60 years later, we once again talk about insurance cartels in the present tense

The State of New York’s complaint against Marsh & McLennan Companies describes “fraudulent, anti-competitive and otherwise unlawful conduct.” Through a “contingent commission” structure the state alleges that Marsh engaged in anticompetitive behavior. According to a Marsh executive quoted in the complaint, Marsh used contingent commissions to determine “who [we] are steering business to and who we are steering business from.” According to wire service reports, New York Attorney General Eliot Spitzer called it “classic cartel behavior.”

It is a dangerous thing for any commentator to write about a breaking news story of this potential importance and scope for a monthly magazine. The writer knows that his or her readers will have more timely and complete facts due to the passage of time; however, even as a scandal begins—and this story has all the markings of a scandal—it is possible to make some observations.

State officials blew it

First and foremost, state officials failed to do the job that Congress charged them to do in 1945. In return for ceding authority to the states to tax insurance, the Congress directed the states to establish a regulatory framework that ended the old cartel system and prohibited the formation of a new one. Nearly 60 years later, we once again talk about insurance cartels in the present tense.

The Marsh scandal provides proof that the state officials have not lived up to that charge—they have not held up their end of the bargain. State legislatures never gave regulators the affirmative statutory authority and guidance to prevent anticompetitive behavior. Without proper authority, there is no reason to think about a proper budget. Some state regulators have actively shirked seeking such authority or budget from their legislatures. There is enough blame to go around.

The McCarran-Ferguson Act of 1945 charges the states to establish an affirmative regulatory framework to protect the public interest that otherwise would be protected by federal antitrust law and fair trade oversight.

New York Attorney General Eliot Spitzer alleges that “Marsh’s conduct had the purpose or effect, or the tendency or capacity, unreasonably to restrain trade and to injure competition and purchasers, both in New York and in interstate commerce, by, among other things: (a) Limiting the number of insurers competing to sell insurance to persons seeking such insurance; (b) Allocating the market for the sale of insurance; and (c) Using inflated bids, prices and other terms of sale with respect to insurance to mask the absence of free and open competition by insurers for the sale of such insurance.”

If Attorney General Spitzer is right—and he usually is—what we have here is an old-time cartel that insurance regulation was supposed to prevent.

NAIC

This is a regulatory failure of national proportions, so one would assume that any effort to respond would be coordinated through the National Association of Insurance Commissioners (NAIC). Where were the regulators who are charged with preventing such actions? Can the states improve the regulatory framework in the face of this scandal?

The NAIC’s vaunted databases of financial, market and enforcement information did not give insurance regulators the tools they needed to uncover the Marsh scheme. The NAIC has adopted a “back-end” regulation approach in recent years. This approach focuses on statistical analysis of market conditions. The analysis seeks to correct problems in the market, but does not attempt to prevent problems.

For nearly a week after news of Spitzer’s complaint broke, the NAIC Web site continued to carry the same headline: “No need for federal regulator, NAIC tells Senate.” The NAIC appeared to stubbornly deny reality at a time when leadership was needed.

The NAIC finally issued a statement in the form of a news release on October 21. “State insurance regulators are actively pursuing all of the facts, assessing the adequacy of current laws or regulations, and will determine appropriate collaborative action involving all states in a very short period of time,” said Diane Koken, NAIC president and Pennsylvania insurance commissioner. “Brokers and insurance companies that have been abusing the system for personal gain will be identified and appropriate actions will be taken to see that all consumers’ concerns are addressed. We intend to coordinate directly with law enforcement officials in identifying and terminating this activity, as well as developing new regulations as needed to better monitor all sales activities.”

The Feds

So if state officials dropped the ball, should the public and ethical insurance professionals look to the federal government to take over where the states have failed? There is a strong case in favor of doing just that—but the devil is in the details.

The proposals for federal oversight of insurance currently before Congress do not inspire confidence in the eyes of consumers or ethical business people. Both the optional federal charter proposal and the federal standards approach promise a weak regulatory environment. The former, based on an impotent “supervisory,” is modeled on the Office of Comptroller of the Currency. The latter uses federal authority to bully states into removing affirmative regulatory review of rates and forms.

There are reasons to support a strong federal regulatory agency. First of all, insurance is interstate commerce. Armed with experience under the Articles of Confederation, the federalist framers of our Constitution rested jurisdiction for interstate commerce with the Congress.

Under the Articles, the states had such jurisdiction. The states acted in parochial ways that hindered the national interest in interstate commerce. Furthermore, when state officials did seek to exert public interest control over growing commercial interests, they often were not strong enough to act. Critics of state insurance regulation have long described the current system as “big fish in little ponds.”

Calls for federal insurance “supervision” are not new. Going back to the Civil War, sectors of the insurance industry have argued for a federal charter. Between the times of the Supreme Court decision in Paul v. Virginia (1868) and the 1930s, insurers brought case after case designed to overturn Paul and clear the way for federal charter legislation.

With Franklin Roosevelt’s revival of federal antitrust prosecutions in the late 1930s, insurers eased their calls for federal jurisdiction. Yet, some insurers chafed under the state-by-state system. As late as the Carter Administration, commercial insurers lobbied for a weak federal regulator to free them from the “50 Monkeys.”

After the repeal of the Glass-Steagall Act of 1999, the call for an “optional federal charter” revived. Insurers found Senate sponsors for such legislation but little support.

Nevertheless, the “threat” of federal legislation proved useful in bullying state officials into regulatory concessions. To push the states further, insurance interests had friends in the U.S. House of Representatives to introduce legislation that would coerce states to lower the regulatory bar even more. At the same time these political games were being played, anticompetitive behavior grew.

Neither the proposal for optional federal charters in the Senate, nor the federal standards proposal in the House, offer policies or practices that seem better suited to prevent, uncover or crush cartel arrangements like the one alleged by Attorney General Spitzer. The current proposals before Congress would make the cartel activities alleged in the New York complaint more difficult to prevent, discover and break.

My guess—and I do believe this is an educated guess—is that if Congress offered industry advocates for federal supervision a weak oversight agency, but applied antitrust law and fair trade oversight to insurers, insurers would balk. These advocates want to have their cake and eat it too! It should not work that way.

Sophistication

The Congress and the NAIC have bought into the belief that sophisticated buyers in the commercial insurance markets should not be hindered by regulatory oversight. For example, the NAIC adopted a model law several years ago that requires regulators to “assume” competitive commercial insurance markets.

In the light of Attorney General Spitzer’s lantern, that assumption appears pretty brash.

In his complaint, Attorney General Spitzer alleged “Unbeknownst to Marsh’s clients, these ‘services’ include steering business to complicit and profiting insurance companies by, among other things, rigging bids and fixing prices.”

In short, sophisticated buyers can fall prey to sophisticated cons.

The Marsh scandal has shaken insurance regulation to its foundations. Nevertheless, that foundation remains sound if anyone chooses to build upon it: The McCarran-Ferguson Act.

The Marsh scandal demonstrates the soundness of that foundation. If the insurance industry is not regulated, then it should be subject to antitrust and Federal Trade Commission oversight. If the public interest demands that insurers engage in some cooperative behavior that is not consistent with federal antitrust law, then the industry should be subject to public oversight through affirmative regulation. It does not serve the interest of the public or the industry to shield insurers from both regulation and antitrust law, as Congressional leaders now propose.

Botched

Pundits have always explained that federal insurance regulation was politically untenable, until and unless there was a massive scandal. As the winds of scandal begin to blow through insurance markets, prognosticators have to ask whether this is the scandal that will bring state regulation to an end.

As facts of the case begin to emerge, it looks as if the state regulators botched this one pretty badly. State regulators allowed a cartel arrangement to operate in property/casualty sectors in direct and clear violation of the McCarran-Ferguson Act.

The alleged cartel arrangement resulted in business practices that should have been seen in market conduct regulation. Furthermore, companies paid fees and brokers realized profits that should have been at least questioned in financial examinations. No market conduct examiner, financial analyst or financial examiner questioned these practices. It took an aggressive attorney general named Spitzer to uncover the new insurance cartel—simply because no one else took the time to look.

If state officials seek to hold on to their jurisdiction over insurance, then the NAIC must rethink the premise behind its vast operation. The NAIC must realize that it is not enough to simply archive information for “back-end regulation.” The NAIC should drive an affirmative regulatory effort to discover problems before they become scandals.

In the best of all worlds, state and federal officials would work together to design “federal standards for state insurance regulation” subject to Congressional and administrative oversight. That model cleaned up a very corrupt Medicare supplement insurance market through the Baucus Amendment to the Social Security Act. Congress sets standards, the NAIC has a short time to develop rules to implement those standards and if the states do not meet the standards, a federal agency assumes regulatory authority in those jurisdictions. The approach is constitutional, tested and reasonable. *

The author
Kevin P. Hennosy is an insurance writer who specializes in the history and politics of insurance regulation. During his career, he 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.