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Public Policy Analysis & Opinion

The fist cartel in Walden's Pond

A legal history lesson for those pondering a challenge to health care reform

By Kevin P. Hennosy

As challenges to the 2010 health care reform law work their way through the courts, one begins to wonder whether historic changes to the legal standing of insurance, as a business and a benefit, might result.

Insurance is imbued with a public interest, which makes it different from other business sectors. This is not the opinion of a magazine columnist—it is settled law.

On April 20, 1914, the Supreme Court issued a decision in the case of German Alliance Ins. Co. vs. Lewis, 233 U. S. 389 (1914).

The principle we apply is definite and old, and has, as we have pointed out, illustrating examples. And, both by the expression of the principle and the citation of the examples, we have tried to confine our decision to the regulation of the business of insurance, it having, become "clothed with a public interest," and therefore subject "to be controlled by the public for the common good."

The case arose in response to insurance reform legislation passed by the progressive Republicans in the Kansas General Assembly. The law required fire insurance companies to submit statistical justification for the rates charged by the companies to the Kansas Insurance Department before offering them for sale.

Within a year of the passage of the Kansas law, independent insurance agents in Missouri successfully lobbied the legislature to secure a similar law in the Show Me State. The Missouri law included a provision that exempted fire insurers from state antitrust law to the extent that their business received regulatory oversight. This construction became the model for the McCarran-Ferguson Act in 1945.

The two state legislatures proved open to these actions because businesses and individuals in both states complained that fire insurance was unaffordable to the point of making the product unavailable. Insurance agents joined the lobbying effort in Missouri because the operations of the carriers placed them between the proverbial rock and a hard place. Customers wanted to buy product, but anti-competitive rules and practices instituted by the carriers made it impossible for agents to meet customers' needs.

Insurance carriers, prompted by the German Alliance decision, challenged the concept of governmental oversight of the price of their products. Among other provisions, the Kansas law established:

Sec. 3. When the superintendent shall determine any rate is excessive or unreasonably high, or not adequate to the safety or soundness of the company, he is authorized to direct the company to publish and file a higher or lower rate, which shall be commensurate with the character of the risk; but in every case the rate shall be reasonable.

Furthermore, the Kansas law placed restrictions on how those rates were applied to customers:

Sec. 7. No company shall, directly or indirectly, by any special rate or by any device, charge or receive from any person a different rate of compensation for insurance than it charges or receives from any other person for like insurance or risks of a like kind and hazard under similar circumstances and conditions in the state. Any company violating this provision shall be deemed guilty of unjust discrimination, which is declared unlawful.

The insurance sector, through the suit brought by German Alliance Insurance, challenged the government's power to exert control over these and other private business activities. The plaintiff complained that applying government regulation to its business behavior was an unconstitutional restriction on insurers' liberty and property without due process of law under the 14th Amendment.

The insurers' argument rested on "The Slaughterhouse Cases," a Supreme Court decision arising from a series of cases in 1873, which argued against state action.

The Slaughterhouse Cases arose from an attempt by the Louisiana State Legislature to protect the health and welfare of the people of New Orleans by regulating a cluster of slaughterhouses upriver of the city. Officials wanted the slaughterhouses and butchers relocated because the facilities had thrown animal carcasses and entrails into the river above the city's drinking water intake, which resulted in cholera and other disease outbreaks in New Orleans.

The legislature chartered a new corporation and required the slaughterhouses and butchers to move to a new facility, which the butchers resisted because the new facility would be racially integrated.

The Court overruled the City's ability to regulate the slaughterhouses and butchers by concocting the concept of all persons having separable citizenship in both the United States and an individual state.

The German Alliance case was one of the first to reject the decision in the Slaughterhouse Cases.


On August 3, 2010, the 20% of Missouri registered voters, representing perhaps 4% of eligible voters, who turned out to vote in primary election, "overwhelmingly" passed a referendum, Proposition C, which was critical of the Patient Protection and Affordable Care Act of 2010 (ACA).

The referendum prohibits the state from compelling "any person, employer, or health care provider to participate in any health care system." The initiative was an effort to take state action to nullify a federal law—an unconstitutional tactic. Two centuries of jurisprudence and The Civil War settled that.

This provision of state law stands in direct conflict with the federal law's requirement for individuals to secure "minimum essential [health care] coverage" or pay a penalty. The individual mandate was a proposal championed by Republican officeholders since the early 1990s. Drafters added the individual mandate to the ACA at the urging of the leading health insurance trade association.

In a series of states, opponents of universal health care financing filed federal court challenges to the law. One such challenge was filed in the matter State of Florida, et al., v. United States Department of Health and Human Services, et al.

Under pressure from the Republican dominated state legislature, the Democratic Missouri Attorney General Chris Koster filed an amicus curiae brief with the United States Court of Appeals for the 11th Circuit in that Florida case.

Show me your metaphor

The resulting brief seemed to please no one when Koster filed it on April 11, 2011. Opponents of the ACA criticized the brief for not going far enough to condemn the law. Proponents of federally guaranteed universal health care financing criticized Koster for being the only state attorney general from the Democratic Party to file an amicus brief in the case. Because Koster had switched parties to become a Democrat just prior to running for attorney general in 2008, critics from the political left rhetorically pummeled him as "Koster the Imposter," when he filed the brief. (In the spirit of full disclosure, I voted for Mr. Koster in the primary and general elections.)

The Koster brief established his standing to intervene in the case through an amicus curiae filing by observing: "Because of the Supremacy Clause, the validity and impact of Proposition C depends on the constitutionality of the ACA provisions with which Proposition C conflicts."

In other words, as established by centuries of case law and the Civil War, federal law is supreme to state law unless the former is inconsistent with the Constitution.

Defenders of the ACA tend to focus on the well-established federal power to tax: the penalty is viewed as a tax paid when individuals fail to support the system through premium payments—which are subsidized through credits. From this viewpoint, the penalty is no different from a payment due at the end of tax year when a taxpayer fails to make enough estimated tax payments or claim enough deductions or credits. Legally this is not deemed a "police function."

However, opponents of the health care law charge that the individual mandate rests outside the jurisdiction of the Constitution's Commerce Clause, and the penalty amounts to the establishment of a federal police power. The states could impose an individual mandate but the federal government could not. The Koster brief continues:

Put another way, when Henry Thoreau set about to idly chronicle the summer of 1845 alongside Walden Pond, could Congress assert that Thoreau's season of reflection was, in fact, an active decision not to fish Walden's waters, regulate his negative decision under the Commerce Clause, and thereafter penalize his failure to fish under the theory that everybody has to eat? No. While the state of Massa­chusetts could have compelled Thoreau to either fish or pay a fine under the state's authority to regulate the health, safety, and welfare of its citizens (i.e., police power), see Jacobson, 197 U.S. at 24-25, the United States Congress, relying solely on the Commerce Clause, could not.

Of course, there are some differences between fishing in a pond and interstate commerce in a commodity called risk. While the use of the Thoreau fishing metaphor is a colorful one, simple metaphors can undermine reasonable discussion of complex issues.

For example, what if we were to learn that large numbers of latter-day Thoreaus may not be fishing because the fish are controlling the price, value and procedures for their capture. What if we learned that the fish hid collusive-behavior behind a national association supposedly in order to protect a trademark, in order to wield cartel power in the little pond?

The German Alliance decision addresses the fallacy of viewing insurance as fishing or shopping in the market:

We may venture to observe that the price of insurance is not fixed over the counters of the companies by what Adam Smith calls the higgling of the market, but formed in the councils of the underwriters, promulgated in schedules of practically controlling constancy which the applicant for insurance is powerless to oppose, and which therefore has led to the assertion that the business of insurance is of monopolistic character, and that "it is illusory to speak of a liberty of contract."

Insurance as commerce

The Florida case focuses on whether insurance is interstate commerce because the Constitution affords Congress jurisdiction over interstate commerce.

When I read the opinion of the Missouri AG, I was surprised that he did not rely on the decision that established the business of insurance—the relationship between insurer and insured—was interstate commerce: United States v. South-Eastern Underwriters (SEUA), 322 U.S. 533 (1944).

In the SEUA decision, the Court first ruled that the business of insurance—consisting of insurer and insured—was commerce, and interstate commerce. Justice Hugo Black wrote:

Ordinarily courts do not construe words used in the Constitution so as to give them a meaning more narrow than one which they had in the common parlance of the times in which the Constitution was written. To hold that the word "commerce," as used in the Commerce Clause, does not include a business such as insurance would do just that. Whatever other meanings "commerce" may have included in 1787, the dictionaries, encyclopedias, and other books of the period show that it included trade: business in which persons bought and sold, bargained and contracted.

Interstate commerce includes customers and potential customers. Furthermore, Justice Black settled the question as to whether insurance was interstate commerce and therefore subject to federal jurisdiction:

Interrelationship, interdependence, and integration of activities in all the states in which they operate are practical aspects of the insurance companies' methods of doing business. A large share of the insurance business is concentrated in a comparatively few companies located, for the most part, in the financial centers of the East. Premiums collected from policyholders in every part of the United States flow into these companies for investment. As policies become payable, checks and drafts flow back to the many states where the policyholders reside. The result is a continuous and indivisible stream of intercourse among the states composed of collections of premiums, payments of policy obligations, and the countless documents and communications which are essential to the negotiation and execution of policy contracts.

Individual policyholders living in many different states who own policies in a single company have their separate interests blended in one assembled fund of assets upon which all are equally dependent for payment of their policies. The decisions which that company makes at its home office—the risks it insures, the premiums it charges, the investments it makes, the losses it pays—concern not just the people of the state where the home office happens to be located. They concern people living far beyond the boundaries of that state.

The opinion given by Justice Black remains settled law, if not more so thanks to technological changes since it was decided on June 5, 1944. Nevertheless, considering the strongly ideological conservative members of the Court, it is possible that insurance—not limited to health insurance—could be ruled to be something other than interstate commerce against all logic.

Insurance and the public interest

It is important to note that before the SEUA decision, going back to 1868, insurance was not viewed as commerce, let alone interstate commerce, by the federal courts. The decision in the German Alliance case is not based on an interpretation of the Commerce Clause of the Constitution.

The opinion relies on a logical framework drawn from a series of cases dealing with grain elevators. From the opinion in the case of Budd v. New York, 143 U. S. 517 (1892) the Court cited the following tenet: "The underlying principle is that business of certain kinds holds such a peculiar relation to the public interest that there is superinduced upon it the right of public regulation."

Even if the courts rule that insurance is something other than interstate commerce, legal history provides ample tools to construct a strong regulatory framework. What we lack are officials and business leaders with the intelligence and backbone to serve the public interest.

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.


Although the 1944 SEUA opinion remains settled law…it is possible that insurance—not limited to health insurance—could be ruled
to be something other than interstate commerce against all logic.











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