Forces of Change

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The U.S. Supreme Court’s 1944 decision in U.S. v. South-Eastern Underwriters Association probably didn’t receive much public attention at the time. Besides covering the tedious domain of insurance regulation, it was released June 5, the eve of D-Day.

But South-Eastern Underwriters nevertheless represented an audacious step for the justices. The divided court ended 150 years of state regulatory domination over insurance. The ruling rejected a 19th-century precedent that the business doesn’t involve interstate commerce and thus lies outside federal jurisdiction. The decision also allowed federal prosecutors to pursue nearly 200 of the association’s member companies on criminal price-fixing charges. 322 U.S. 533.

Congressional reaction was swift and equally bold. In less than a year, President Franklin D. Roosevelt signed the 1945 McCarran-Ferguson Act, passed under intense industry pressure, to restore state regulation and codify an antitrust exemption that insurers long had claimed.

A little more than 60 years later, the McCarran-Ferguson Act is getting another look as Congress—and even some insurance companies—re-examines the wisdom of allowing 50 different state regulators to govern a national industry in 50 different ways.

“We’re one country,” says Tom Baker, director for the University of Connecticut Insurance Law Center. “Nobody does this with soap, or even securities.”

Though long criticized as antiquated and unfair by consumer advocates and other industry outsiders, the antitrust exemption is now losing the support of large segments of the insurance industry itself.

And some companies that once considered federal regulation heresy are now fed up with inconsistent, cumbersome procedures at the state level and want regulation so badly that they are willing to surrender McCarran-Ferguson’s exemption to get it. They are pushing for legislation that would allow them to choose a single federal charter over many and varied state licensing regimes.

“The interest today is not just coming out of nowhere,” Baker says. “Since the Sept. 11 and the Katrina experiences, we’ve seen a heightened interest from the industry.”

Insurers say another massive terrorist strike or catastrophic hurricane could financially devastate the industry.

Moreover, the industry faces increasing competition from other sectors and says crazy-quilt state regulation hampers its ability to keep pace.

Much is at stake for consumers and insurers alike in an industry in which companies wrote nearly $1 trillion in life, property and casualty policies alone in 2005.

“Insurance is the backbone of our economy, and all lawyers have an interest in keeping it healthy, or we’re going to have trouble with all our clients,” says veteran Philadelphia lawyer Eric D. Gerst, who has represented policyholders and companies in insurance cases. “We’re always looking for someone to pay that claim.”

Congress has taken on McCarran-Ferguson and state regulation more than once before, only to back down each time. This time around, though, industry leaders say the lawmakers may mean business.


Since the act, states have been policing the industry through legislation, direct administrative regulation and the courts.

State court systems play key roles in interpreting and setting the parameters for regulation. Like other businesses, insurers and their trade associations complain just as loudly about regulation imposed by courts as they do about restrictions from legislators or state insurance departments.

For example, a court decision for policyholders in a case brought by Mississippi Attorney General Jim Hood over denied Hurricane Katrina claims could force insurance companies there to drop controversial exclusions for water damage. Though industry lawyers downplay the suit and similar private litigation as fact-based contract disputes, the outcome could have far-reaching implications for property coverage in the Southeast and other disaster-prone areas.

Against that background, some insurance executives are ready to throw off the antitrust exemption’s warm blanket if Congress replaces state regulation with a friendlier and more navigable federal system—as long as it comes without rate caps common in state schemes.

“It’s not just getting federal regulation,” says Washington, D.C., industry lawyer Craig A. Berrington, former general counsel to the American Insurance Association. “It’s getting the right kind of federal regulation. People from the industry would not accept a carbon copy of the state system we know is dysfunctional. There must be a paradigm shift.”

Under McCarran-Ferguson, federal antitrust laws apply only to insurers “to the extent that such business is not regulated by state law,” except in cases where insurers engage in boycotts, intimidation, coercion or other concentrated refusals to deal with particular customers or rival companies to extract concessions from them.

Insurers have maintained the exemption is a narrow one that they need so companies can pool their resources to predict their exposure to risk more accurately. But though courts have held that collective activities tied to rate-making come under the exemption, the line between legitimate cooperation and collusion is a hard one to draw.

Consumer advocates complain the companies abuse the right and use the exemption to illegally fix policy prices, rig bids and allocate sales territories among themselves outside public view. They say the insurance industry should not get a break that no other enterprise enjoys, save Major League Baseball.

Federal courts most often encounter the exemption in insurer-defendant motions to dismiss, and they must determine whether the questioned activity falls within “the business of insurance.”

Courts rarely bend the exemption’s black letter, nor do they consider how effectively or poorly states enforce their own regulations, as long as they have something on the books. Though some experts suggest the courts have somewhat narrowed the exemption over the years, they have approved a gamut of conduct, such as:

• A deal in which medical-malpractice carriers only would sell coverage to members of a county medical association.

• Lower benefits for not using a company-designated funeral director.

• Use of less expensive, nonoriginal parts for auto repairs, which policyholders argued were inferior to original manufacturer’s parts.

• A health insurer’s requirement that patients fill prescriptions at the company’s pharmacy.


Despite success in arguing the exemption to federal judges, major segments of the property-and-casualty and life insurance industries 60 years later would give up that protection for seamless federal regulation. As precedent, they cite the banking system, which since the Civil War has permitted financial institutions to choose state or federal charters.

The big companies especially like a bill introduced in July by Sens. John E. Sununu, R-N.H., and Tim Johnson, D-S.D., that would create a single federal regulator in the Treasury Department. Besides one-stop shopping for product approval, insurers most significantly would escape state price controls, though they would continue to pay state taxes on premiums. A House equivalent surfaced in early October, but serious consideration of any proposal likely will wait until some months after a new Congress convenes this month.

For the most part, the insurance companies pushing for optional federal charters are national or international concerns that want to escape the cost and delays associated with getting state insurance commissioners to approve both rates and new types of policies, which can take years.

“By the time approval is given, the product often is obsolete,” says Frank Keating, president and CEO of the American Council of Life Insurers, whose 377 member companies account for more than 90 percent of the premiums collected on life policies and related instruments.

The insurance industry won’t promise that federal regulation alone will lower premiums. But short of promises, the companies insist that dropping price ceilings will mean increased competition that in turn will translate into reduced consumer costs. Companies pushing federal chartering say it’s worth losing the antitrust exemption if it helps them speed their products to market and lets them charge what they want.

“These people are used to taking risks,” says Marc Racicot, president of the 400-member American Insurance Association, the largest trade group representing property and casualty insurers. “That’s their business, and they know they’re going to be paying money.

“But what if you could spread the risk from Texas to Maine?” asks Racicot, a former Republican National Committee chairman who also chaired President Bush’s re-election campaign. “Our members are always looking for an opportunity to compete, but you can’t stack the deck against them.”

Life insurance carriers don’t deal with the price caps that affect the property and casualty folks. They nevertheless wince at increasing competitive pressure from federally licensed banks and securities firms, which can sell annuities and other life insurance products under the 1999 Gramm-Leach-Bliley Act. As the law now stands, federally chartered banks and related businesses can take new products straight to market, while insurance companies must seek state-by-state approval.

“We can have 15 states going over the same thing,” says Keating, a former Oklahoma governor. “Banks and securities firms don’t go through that. If you have to go through all of that hassle, I’d rather sell a stock.”

Lawmakers won’t be dealing with a fully unified industry, though. While national and international insurers expect to offer more types of policies and make more money with streamlined regulation, smaller state and regional companies and independent agents worry that federal regulation and more competition could land them on the endangered species list.

“I have clients who are strongly in favor of federal insurance regulation, and some who are not,” says Francine L. Semaya, an industry lawyer from New York City who chairs a task force studying modernization of insurance regulation for the ABA Tort Trial & Insurance Practice Section.


Besides the politics involved, taking power from the states and handing it to the feds poses plenty of constitutional and practical questions from the get-go.

The TIPS task force raised 10th Amendment concerns over a 2005 effort to federalize regulation, in part because initial drafts forced states to follow the federal model, which in turn could interfere with their ability to enforce their own laws. Called the SMART Act, for State Modernization and Regulatory Transparency, the proposal was stillborn.

The House may have avoided the federalism question on Sept. 27, when it unanimously agreed to streamline dual taxation, licensing and financial regulation for surplus lines carriers and reinsurance dealers with continued state involvement, instead of the lone federal regulator envisioned under optional chartering.

Surplus lines offer property and casualty coverage for unique or unusual risks unavailable in traditional markets. Reinsurance, commonly described as insurance for insurance companies, spreads risk by backing up companies that write primary customer policies.

From the politicians’ standpoint, uneven criminal enforcement at the state level is expected to become a crucial point in the argument for scrapping the antitrust exemption. The exemption’s demise could level out the inconsistency by bringing federal prosecutors into the picture.

At a June Senate Judiciary Committee hearing, then-Chairman Arlen Specter wondered aloud why New York prosecutors let companies slide short of criminal charges in a bid-rigging case brought under state law that yielded more than $3 billion in restitution and penalties and guilty pleas from 20 individuals. But Specter appeared more concerned that no charges at all resulted in Illinois for the same conduct by the same players, which prosecutors say also was part of the same scheme.

“The feds have a pretty good record in Illinois,” the Pennsylvania Republican said in questioning state Insurance Director Michael McRaith. “Wasn’t there a guy named Capone from that state?”

Some politicians also link professional malpractice insurance rates to the antitrust exemption, suggesting collusion among insurers setting them. One of the first moves in the current re-examination of regulation came from Sen. Patrick J. Leahy, D-Vt., who in 2005 introduced a bill that tried to curb rising medical-malpractice premiums by lifting the antitrust exemption from writers of those policies. That didn’t get far with either the industry or organized medicine, both of which often prefer to blame their problems on lawyers.

Yet more political potholes continue to appear in the road to federal regulation.

“It would die if it wasn’t for the fact that the really big insurance players really want to do something,” says former Texas Insurance Commissioner J. Robert Hunter, now director of insurance for the Consumer Federation of America.

For one, federal oversight would bust up the entrenched regulatory monopoly that state insurance commissioners now hold.

The commissioners are attempting to blunt the move toward federal oversight with an interstate compact that would enable life insurance companies to go to a single, Washington-based executive director’s office to license and sell products nationwide.

“What we have that the federal government doesn’t have is 150 years in this area,” says Maine Insurance Superintendent Alessandro A. Iuppa, president of the National Association of Insurance Commissioners.

“We have the infrastructure, and we have the expertise.”

Though it’s regarded as the leading counteroffer to optional federal chartering, the voluntary compact lacks the force of law and had signed up only 28 states by late September. Moreover, life policies, annuities and the like are basically plain vanilla products whose prices and terms vary little from state to state. Besides, everyone dies, so payout projections hold fairly steady. The compact does not address the thornier question of property and casualty coverage, where the risks vary enormously from one region to the next, or even from one neighborhood to another.

Smaller companies and independent agents, who sell lines from more than one carrier, fear they could be squeezed out of business if their competitors gain new mobility with federal charters. They generally lean toward reforms at the state level, though the agents would force states to modernize their systems through federal legislation, such as the House’s approach to surplus lines and reinsurance. They also say federal oversight may become a bigger disaster than the one it tries to mop up.

One federal naysayer is Charles Symington, chief lobbyist for the Independent Insurance Agents & Brokers of America. “What we don’t want to see is another FEMA for the insurance marketplace,” he says.

The ABA Weighs In

Since 1989, the ABA has supported partial repeal of McCarran-Ferguson’s antitrust exemption so insurers could work together in specific areas not considered restraints on competition, such as standardizing policy forms. In most cases, the ABA policy would forbid insurers from collectively setting rates. The ABA also supports continued state regulation.

Insurers, however, may be able to engage in joint underwriting under the ABA policy in order to, say, spread risk among themselves in high-crime neighborhoods or other areas where insurance is tough to come by. Companies seeking shelter in those safe harbors likely would have to include a strong public service component in their plans, says Donald C. Klawiter of Washington, D.C., immediate-past chair of the ABA Antitrust Section.

“They would be construed narrowly, and competition would rule,” says Klawiter, who testified on repealing the exemption in June before the Senate Judiciary Committee. “We’re trying to help people who could not otherwise get insurance.”


Tangle Over Terrorism Coverage

While experts predict that it could take Congress two years or longer to accomplish a comprehensive regulatory shift for insurance, lawmakers don’t have that kind of time to get terrorism coverage right. They face a Dec. 31, 2007, deadline to either fix it or forget it.

In one of the rare instances of federal involvement with insurance regulation, Congress passed the 2002 Terrorism Risk Insurance Act to help private insurers cover the humongous losses associated with a major attack. The experience with terrorism insurance also illustrates what happens when regulatory worlds collide.

The 9/11 attacks resulted in $36.4 billion in losses for life insurers, workers’ compensation carriers, and commercial liability and property insurers. That figure is expected to grow as continuing litigation is resolved.

But government and private experts warn that losses could approach the $100 billion mark from a larger attack using nuclear, chemical, biological or radiological weapons.

Criticized as giving a gift to the companies, the government under the first version of the act would begin paying for 90 percent of insured losses—to a maximum of $100 billion—once an attack caused $5 million in damages.

As the act steamed toward sunset in December 2005—and as debate over its need increased—Congress temporarily extended it. Though the extension still promises up to $100 billion in federal money to help private insurers, the damage trigger increased to $50 million in 2006; it climbs to $100 million this year.

Discussion on a permanent fix is expected to begin early this year, ahead of the extension’s Dec. 31 expiration.

“It’s got to be a partnership with the federal government to help us get through it,” says Francine L. Semaya, an insurance lawyer from New York City who chairs a task force studying modernization of insurance regulation for the ABA Tort Trial & Insurance Practice Section. “If [insurers] have to pay every claim, we’re looking at a lot of insolvencies.”


The TIPS task force, however, sees a significant granny knot for Congress to untie where the federal program and state regulations cross. Though it requires companies to offer terrorism coverage, TRIA did not address the price. So state regulation still applied.

Some states, notably New York and Florida, as well as the District of Columbia, lowered their rates. That may improve availability of coverage in those places, but at the expense of policyholders in other states whose rates could consequently increase.

To remedy that, the task force recommends that Congress pre-empt state price ceilings, perhaps by flatly abolishing them or by setting a single national price. The task force notes similar problems with covering fire damage associated with terrorism and recommends pre-empting mandatory fire coverage in 17 states to increase competition and lower premiums.

Nevertheless, the panel still sees fairness problems in dropping state controls or in setting a national price. But though prices in some states may rise with simple pre-emption and nothing more, the panel sees them dropping in the long run because of increased competition.

On the other hand, a set national price could pose a more enduring dilemma, because policyholders in low-risk states may forgo terrorism coverage if it costs too much, while those in high-risk states may not pay enough.

But such regulatory obstacles may be overstated, according to a long-anticipated report released Oct. 2 by President Bush’s Working Group on Financial Markets. The treasury secretary heads the working group, which includes the chairs of the Federal Reserve Board, the Securities and Exchange Commission, and the Commodity Futures Trading Commission.

The working group suggested that many states may exempt terrorism from price controls on large commercial policies. The group also suggested that some companies actually may not charge extra for terrorism coverage, while big policyholders have access to unregulated surplus lines, which come from out of state. The report, however, was unable to pinpoint why 40 percent of all policyholders continue to go without terrorism coverage.

“They don’t have it because they can’t afford it,” Semaya says.

Still, the group didn’t recommend dropping the federal guarantee. Toss in the prospect of unconventional nuclear, biological, chemical or radiological attack, and the prospect appears grim for pure private expansion of coverage, according to another report released Sept. 25 by the Government Accountability Office.

Semaya sees tension between the government’s reluctance to back terrorism coverage and the current excitement over a broader regulatory transformation. Something just doesn’t sit right when the government on one hand tells the industry it doesn’t need the help in case terrorists strike again in a big way.

“But at the same time, they want to tell us how to run our business,” says Semaya. “If the federal government is walking away from TRIA, why would they want to get their hands dirty regulating insurance?”

John Gibeaut is a senior writer for the ABA Journal.

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