Thursday, March 6, 2014

Beyond McCarran–Ferguson

In January, I attended an insurance conference in Florida where I had the lucky opportunity to pose a question to Florida's Insurance Commissioner Kevin McCarty and Representative Bryan Nelson.  I asked, "What are some of the reasons that proposals for regional and national catastrophe insurance pools fail?"

The question was first met by silence and then very quick agreement between the two men that the policies fail due to a lack of public political will.  As one of them explained (I forget which one and I paraphrase), "It is hard enough to get northern Louisiana to share risk with Southern Louisiana, let alone multiple states to share risk."

If there is one thing that I have learned from studying political science, it is that when the public is blamed for policy failure there is a far more interesting story to be found in the details.  In any case, when a republican politician and an insurance regulator emphatically and quickly agree on something, one should get a second opinion.

Inspired by the response I received, I became curious about why the states' regulate insurance in the first place.  In general, this question is often met with the brief response that the McCarran-Ferguson Act of 1945 (MFA) explicitly gives the states authority to regulate the insurance industry and so, they do.  But this does not sufficiently explain the reasoning behind the "Why?"  MFA simply provides the legal authority for the states to do so.

The question is worthwhile asking because throughout American history numerous instances demonstrate presidents and policy makers seeking Federal regulation of the insurance industry.     One of the continual proponents of Federal regulation has been the insurance industry itself, at least at one point,
"consider[ing] it more advantageous to be regulated by a toothless, laissez-farish mastiff like the Federal Government than by those smaller but possibly more harassing watch dogs, the individual states” (quoted in Alt 2010).  
The MFA was born from a need to clearly designate regulating power after the Supreme Court ruling on the United States v. South-Eastern Underwriters  Association (hereafter as USSEA).  The case challenged a long held precedent that the business of insurance is not commerce and therefore exempt from federal anti-trust regulation and any regulating authority designated to Congress through the Constitutions' commerce clause.

The Supreme Court engrained the precedent in 1869 with the ruling in Paul v. Virginia (PV)- only a few years after the end of the American Civil War.  The contentions bringing about the Civil War were evident in the PV case as the two issues of focus were: 1) the right of citizens of one state to the "privileges and immunities of citizens in the several states" and Congressional power "to regulate commerce with foreign nations, and among the several States."  Moreover, the case involved a New York insurance agent (Yankee) attempting to do business in Virginia (Confederate).

The practicality of the dispute was regulatory authority and taxing ability over the insurance industry.

Justice Stephen Johnson Field, undoubtably aware of the sensitive nature over state's rights that remained after the war, seemed to find a balance between upholding the, then, delicate ideas about freedom and state authority over their respective economies.  Justice Field argued extensively for citizens' right to move about the nation, acquire and enjoy property and pursue happiness,
Indeed, without some provision of the kind removing from the citizens of each State the disabilities of alienage in the other States, and giving them equality of privilege with citizens of those States, the Republic would have constituted little more than a league of States; it would not have constituted the Union which now exists. 
Yet, the extension of this right to corporations made up of citizens was marred by complications, particularly, corporations' ability to amass wealth and power,
The corporation being the mere creation of local law, can have no legal existence beyond the limits of the sovereignty where created. ... Having no absolute right of recognition in other States, but depending for such recognition and the enforcement of its contracts upon their assent, it follows as a matter of course that such assent may be granted upon such terms and conditions as those States may think proper to impose....The whole matter rests in their discretion. 
If, on the other hand, the provision of the Constitution could be construed to secure to citizens of each State in other States the peculiar privileges conferred by their laws, an extraterritorial operation would be given to local legislation utterly destructive of the independence and the harmony of the States. At the present day, corporations are multiplied to an almost indefinite extent. There is scarcely a business pursued requiring the expenditure of large capital, or the union of large numbers, that is not carried on by corporations. It is not too much to say that the wealth and business of the country are to a great extent controlled by them. And if, when composed of citizens of one State, their corporate powers and franchises could be exercised in other States without restriction, it is easy to see that, with the advantages thus possessed, the most important business of those States would soon pass into their hands. The principal business of every State would, in fact, be controlled by corporations created by other States.
Finally, Justice Field argued that regardless of the whole discussion of citizenry and freedom, there is nothing inherently keeping Congress from regulating insurance if it were that insurance was commerce which Field argued quite clearly that it is not,  
Issuing a policy of insurance is not a transaction of commerce
When the Sherman Act came about in 1890, seemingly everyone assumed insurance to be exempt from that, too.

Shortly after the PV ruling, state insurance commissioners created the  National Association of Insurance Commissioners (NAIC) in response to a felt need for some type of organization and consistency of regulation amongst the states.  

With the Great Depression, the federal government became fervent investigators of potential monopolies and their prevention.  According to Alt (2010), research by the federal government found that states were having trouble regulating the industry because of business was concentrated in just a few companies.  

In 1942, the US Justice Department filed suit against the South- Eastern Underwriters Association charging them with fixing premiums and boycotts.      

Justice Hugo Black gave the majority opinion on the case in which he argued that the discussion of
insurance being or not being an act of commerce was ridiculous,
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.  And this meaning has persisted to modern times. Surely, therefore, a heavy burden is on him who asserts that the plenary power which the Commerce Clause grants to Congress to regulate "Commerce among the several States" does not include the power to regulate trading in insurance to the same extent that it includes power to regulate other trades or businesses conducted across state lines.  
Justice Black argued that one of several reasons causing the courts to uphold the precedent set by PV was to ensure that at least some one, anyone, was regulating the industry,
In all cases in which the Court has relied upon the proposition that "the business of insurance is not commerce," it [sic] attention was focused on the validity of state statutes the extent to which the Commerce Clause automatically deprived states of the power to regulate the insurance business. Since Congress had at no time attempted to control the insurance business, invalidation of the state statutes would practically have been equivalent to granting insurance companies engaged in interstate activities a blanket license to operate without legal restraint. As early as 1866, the insurance trade, though still in its infancy, was subject to widespread abuses. To meet the imperative need for correction of these abuses, the various state legislatures, including that of Virginia, passed regulatory legislation.  Paul v. Virginia upheld one of Virginia's statutes. To uphold insurance laws of other states, including tax laws, Paul v. Virginia's generalization and reasoning have been consistently adhered to.
The practicality of the case was not just regulating and taxing authority but applicability of federal anti trust legislation to the insurance industry.  The two opposing schools of thought on the matter being: 1) Unregulated competition in the insurance industry (i.e. exemption from anti-trust) is not good for the public interest; and 2)  The business of insurance is different from all other forms of commerce and therefore the anti-trust laws ought not apply.

Justice Black concluded that the decision to regulate or not to regulate the insurance industry was not for the Court to decide, though he did state that the Court regarded the argument that the Sherman Act invalidated state laws as "exaggerated."  On the basis that insurance is commerce the Court reversed the PV ruling.  Congress was then free to regulate the insurance industry however they deemed fit.

The Supreme Court made their USSEA ruling on June 5, 1944- the day before D-Day.  As Congress began dealing with legislation to address their new found responsibility, the NAIC argued for continued regulation and taxation by the state and not the federal government and proposed a bill to Senators Pat Mccarran and Warren Ferguson which ultimately became the McCarran-Ferguson Act.

The MFA was accepted by Congress with little change.  Jones (2004) argues that MFA was so readily accepted because southern states were resentful towards New Deal policies and the stirring of civil rights debate brought up by WWII.  This gave them reason to fight for the preservation of state regulating authority based on feelings about state rights.  The north and midwest had an interest in preserving state regulating authority because most of the insurance companies were headquartered in north and midwest states and they were enjoying the tax revenue.  

The resulting MFA preserved state regulating and taxing authority of the states.  Federal antitrust regulation applies to insurance "to the extent that such business is not regulated by the state."  I have seen it argued that the MFA works to partially exempt insurers from anti trust legislation because it is unclear as to how best to interpret the above clause.

The NAIC then began drafting model laws for use by the states. 

As Randall (1998) explains the NAIC has a conflicting duel role of centralizing regulation and preserving state regulating authority.  The NAIC is not a government organization, has no accountability to voters, is not subject to government oversight, and is directly funded by the insurance industry.  The NAIC acts to centralize insurance regulation enough but not so much as to impose undesired federal legislation upon the industry.

So, why then?
It seems the reason states regulate insurance for two main reasons:
  1. Deep rooted american values regarding the division of power between state and federal government
  2. The need or desire to readily negotiate and manipulate localized market competition to meet the needs of the state and its economy at any given time
To a lesser degree, a third reasons is found in the political power and influence of the NAIC.

So, what then?
For one thing, the self interested power of the NAIC and their ability to effectively regulate ought to get further attention.  I may explore this in the future.

The main take away however, is that there is no historic precedent for a lack of public political will to share risk.  Indeed, as part of the Federalist Papers #45, James Madison argued,
The operations of the federal government will be most extensive and important in times of war and danger; those of the State governments, in times of peace and security.
States regulate insurance so that they can respond, uphold and encourage the public values and behavior for which they choose.  And presumably, they like having the tax revenue.  The set up also seems favorable for federal government because it waters down the power the insurance industry would otherwise amass if it could effectively organize at a national level.  

Though I have yet to look into the Congressional debate over the different bills for national and regional catastrophe coverage pools, I now have a historical context for understanding whatever I find.  If the proposals get bound up in Civil War era dialog of state rights then the status quo holds.  However, if the dialog has changed then it is worth understanding how and why it changed after remaining the same for over 100 years.