To The Point
The battle of the ages still rages
Should McCarran—Ferguson be scrapped in favor of an optional federal charter?
By Emanuel Levy
Has state regulation of insurance been an abject failure that has never served the interests of the public or business? Has it just been inept and incapable of keeping the insurance companies adequately regulated and providing the public with a viable product at favorable rates? Should state regulation be scrapped and replaced by the federal government, or should the system of optional federal charters be superimposed on the current regulatory system? Has the insurance business, over all the years, been in violation of the antitrust laws, but beyond prosecution because of the McCarran-Ferguson Act?
In this observer’s opinion, there has never been any viable evidence showing that state insurance regulation has failed to fulfill its obligations to the public or to the industry. There has been no ringing public outcry that insurance departments have not responded to the public over the years. To the contrary, there is sufficient evidence in the reports by state insurance departments of strong disciplinary actions against insurance companies, agents and brokers for actions that violated the law or regulations, or that were inimical to the interests of policyholders. Many, if not all of the departments issue monthly reports on disciplinary actions, showing fines or even revocations of licenses where called for.
It does not appear probable that this could be handled better on a federal level. Examination of federal regulation in the banking area reveals major failures in the savings and loan debacle and the current subprime mortgage disorder as well as other federal agency failures.
There is little doubt, however, that the Katrina/Rita experience served as a springboard for charges of insurance industry failure to live up to obligations to protect the public. That is most strongly underscored in a statement released by Sen. Patrick Leahy (D-Vt.), chairman of the Judiciary Committee, accompanying the introduction of The Insurance Industry Competition Act of 2007 (S.618). He said in February 2007, “Federal oversight would provide confidence that the industry is not engaging in the most egregious forms of anticompetitive conduct—price fixing, agreements not to pay, and market allocations. Insurers may object to being subject to the same antitrust laws as everyone else, but if they are operating in an honest and appropriate way, they should have nothing to fear.”
He added that consumers “have the right to be confident that the cost of their insurance, and the decisions by their insurance carriers about which claims will be paid, reflect competitive market conditions, not collusive behavior.”
Similar comments have been made by other members of Congress and by representatives of consumer organizations. A very strong statement by Sen. Trent Lott (R-Miss.), a member of the Judiciary Committee, was made in the midst of the legal wrangles is Mississippi and Louisiana over flood vs. windstorm damages. Lott’s own home was destroyed in the Hurricane Katrina disaster. He charged the insurance industry with collusive actions on rates and claims, comments identical with those of Chairman Leahy. Sen. Lott very strongly complained that the absence of antitrust regulation, by virtue of McCarran-Ferguson, gave insurers this freedom to engage in antitrust violations.
However, those seeking the repeal of McCarran-Ferguson are lashing out without examining the history of the law or its application over the decades it has been in effect.
Historical perspective
McCarran-Ferguson was signed into law in 1945 by President Franklin D. Roosevelt to protect the insurance industry from imploding. The law was in response to the U.S. Supreme Court decision in United States vs. Southeastern Underwriters Association, which established the doctrine that insurance was commerce and when conducted over state lines, interstate commerce.
That decision effectively ended the right of the rating organizations, such as the SEUA, to collect loss and cost data from individual insurance companies in order to establish in concert uniform rates to be used by insurers in underwriting businesses.
Because of the nature of the business of insuring risk, it was essential to examine the experience of the entire industry. Therefore, rating bureaus were, as they still are, absolutely essential to review the broad picture inasmuch as companies, individually, do not have the statistical data on which to base rate structures. That was, per se, concerted action in violation of the antitrust laws.
McCarran-Ferguson was designed to permit the continuation of the collection of rating data and the establishment of rates, without which the business could not operate. The law did not then, nor does it now, give the insurance business the right to violate the Sherman Antitrust Act, or any similar statute.
NAIC weighs in
With respect to the adequacy of regulation of the insurance business, Catherine J. Weatherford, the executive vice president and CEO of the National Association of Insurance Commissioners, lashed back at a statement made by Rep. Paul Kanjorski (D-Pa.), quoted in “Roll Call,” that there needs to be “better federal oversight of the insurance business.” She said in a statement released February13, 2008, that the congressman was wrong, and that the current problems in the market “were caused by the failure of federal—not state—regulation.”
Weatherford offered substantiation for her challenge to the congressman, asserting that “lax federal oversight caused the current disruption in the bond market.” She said that it was the Office of the Comptroller of the Currency, a federal agency, that allowed banks “to offer unaffordable subprime loans to home owners over the objection of state regulators …”
She went on to accuse the Federal Reserve Board of allowing banks “to hold risky derivative investments based on these subprime loans, resulting in billions of dollars of write-downs.” Adding the Securities and Exchange Commission to the list of faulty federal regulation, the NAIC executive declared: “Everyone on the federal level who contributed the kindling, logs and matches that caused this fire should not now take away authority from state regulators who have been keeping the flames in check.”
Weatherford made specific reference to the job of state insurance regulators with respect to bond underwriters and their responsibility to insure structured debt instruments. Since federal oversight has obviously failed, and this business model hinges on opinions of for-profit rating agencies, “we are now considering a business model that is based on financial strength ratings developed by state regulators. Further, we have already added additional capacity to the municipal bond insurance market so that government bond insurers do not suffer because of lax federal oversight.”
All in all, this has not been a good time for federal regulation. It is my opinion that S 618—which would endanger the McCarran-Ferguson Act as well as the status and state insur-ance regulation—will never get enacted.
Federal insurance chartering
There is little argument that state regulation is full of duplicative demands because 50-plus jurisdic-tions call for repeated action, whether it is licensing, rate approvals, laws, regulations or tax and fee demands. Does that make the single federal regulatory system superior? Perhaps it does for those companies choosing the charter that are sufficiently large and sophisticated, but not necessarily for the industry as a whole, the purchaser of insurance, or the regulatory system.
As to licensing, the NAIC is engaged in a project calling for a comprehensive review of state producer licensing laws, practices and procedures. Producers will be happy if the project succeeds and the states move to adopt it. A similar study should be conducted on insurer licensing.
There are sharp differences among those favoring the shift to an optional federal charter system and those who oppose it. In mid-February, Kansas Insurance Commissioner/NAIC President Sandy Praeger responded to a statement by Marc Racicot, president of the American Insurance Association (AIA), who is in favor of the optional charter and was asking insurance commissioners to reconsider their opposition to the proposal. She sent a letter to Racicot, a former state governor, emphasizing the significance of insurance-related issues to the consumer.
Commissioner Praeger’s letter to the AIA president, made public in a press release dated February 15, 2008, pointed out that there are presently 11,000 individuals working in state insurance departments across the country. She said that it takes quite an imagination to believe that the U.S. Treasury Department, which would be the regulating authority under the optional charter arrangement, could assume even a partial role in supervising insurance, without creating a huge bureaucracy. And she added that “the plain and simple truth is the federal chartering would create a new bureaucracy from scratch and allow insurance companies to ‘opt out’ of comprehensive consumer protection and state oversight.”
She added that the current proposal would “gut consumer protection, while outsourcing most critical regulatory functions to an industry-run self-regulatory organization.”
Commissioner Praeger’s lengthy commentary takes up key aspects of the proposed federal system pointing out, among other things, that the National Insurance Act, which would create the dual system, would ultimately result in the loss of premium revenues by the states. She also sought to counter the argument made by the sponsors of the charter proposal that it works with the banking industry, which has both federal and state banks. Praeger emphasized the differences between banking and insurance and the protection of the consumer.
No matter how simple the sponsors try to make the chartering proposal sound, it really constitutes a major change in how the business would operate. One thing is certain; there is nothing that the federal government does that is a panacea for simplicity. In January 2005, the Competitive Enterprise Institute, an independent think tank, released a comprehensive issue analysis paper written by one of its staff experts, Catherine England. The subtitle, referring to the federal insurance chartering was, “The Devil’s in the Details.”
The future for the insurance business is fraught with uncertainties; and individual insurance brokers and agents, as well as rank and file insurers, need to be alert about what is happening and be mindful of the positions of their associations so that they can lend their support toward reaching favorable solutions. n
The author
Emanuel Levy, editor of Insurance Advocate from 1958 to 2004, joined the weekly insurance news magazine in 1946 after serving with the United States Army. He has appeared as a speaker at meetings and seminars across the country sponsored by producers’ and other industry associations, and is the recipient of many awards and citations. He served on the faculty of the College of Insurance for the annual orientation course for incoming insurance regulators and staff members, lecturing on the debate over state and federal regulation of the insurance business. He wrote insurance articles for The Economist magazine, and for many years was insurance section editor of the World Book Encyclopedia’s annual historical review book.