McCarran repeal: Beware of negative unintended consequences

The McCarran-Ferguson Act enacted in 1945 provides for the continued regulation of insurance by the states and a narrow exemption from the general federal antitrust laws. The exemption is limited to activities that constitute the “business of insurance,” are “regulated by state law,” and do not constitute “an agreement to boycott, coerce or intimidate or an act of boycott, coercion or intimidation.”

Congress is exploring whether the McCarran-Ferguson is good for consumers, and the answer is a resounding yes. The application of the McCarran-Ferguson limited exemption has worked well for decades to promote and maintain a healthy, vibrant and competitive insurance marketplace, to protect the nation’s policyholders, and to ensure the financial integrity of the industry.

There are more than 5,000 insurers operating in the United States, the majority of which are relatively small. A number of studies over the years, including those done by the U.S. Department of Justice, state insurance departments and economists, have concluded that the insurance industry is very competitive. The competitiveness is further evidenced by the National Association of Mutual Insurance Companies’ membership in terms of size, geographic dispersion, lines of business and corporate structure.

The McCarran-Ferguson exemption has made it easier for small and medium size insurers to compete and enabled the development of specialized and niche markets. The exemption promotes competition by allowing companies to exchange critical data regarding losses and other factors, facilitating participation and oversight of state guaranty funds, permitting state control over liquidations and enabling the operation of assigned risk plans.

The limitations apply only to the “business of insurance,” which is undefined in the statute. Prior to 1969, courts generally construed the term to include virtually all activities engaged in by an insurance company; however, the Supreme Court narrowed the provision in SEC v. National Securities Inc., 393 U.S. 453, 459-60 (1969), distinguishing the “business of insurance” from the “business of insurance companies.” The court developed a three-prong test to decide whether an activity constitutes the “business of insurance:” 1) whether the activity transfers or spreads a policyholder’s risk; 2) whether it is an integral part of the policy relationship between the insurer and the insured; and 3) whether the activity is limited to entities within the insurance industry.

Reflecting the concern of Congress over the difficulty of underwriting risks in a responsible way, the courts have generally found that activities facilitating the exchange of information necessary to ratemaking constitute the “business of insurance.” The limited exemptions facilitate standardization of risk classification and policy language, which help make data more credible and enable consumers to better compare offers.

Insurance is fundamentally different from other products in that it is a promise of future financial obligations. As such, insurers lack complete information about the ultimate cost of the product at the time of sale. Consequently, the policy premium is based on a best estimate of those costs. To develop these best estimates, insurers rely on information from a large number of losses over a significant period of time. Few insurers, however, are able to develop actuarially credible rating information through their internal loss experience alone. This is particularly important for smaller and medium sized companies. Without advisory loss cost data, they would be unable to compete with larger companies.

In addition, many insurers use supplemental information developed by licensed advisory organizations such as the Insurance Services Offices. This information would be prohibitively costly or not be available at all if insurance companies were constrained from reporting data as the result of antitrust exposure.

The limited antitrust exemption also allows insurers to form intercompany pools or syndicates to provide high-risk coverage and allows small companies to participate in writing risks that would be unavailable on an individual basis. In addition, the limited exemption is key to joint underwriting associations and residual market mechanisms.

Over the years, there have been proposals to limit or repeal the antitrust exemption. Proponents often ground their calls for repeal on assertions that the exemption has led to collusion within the industry. There has been no evidence to support the assertions.

Others have recommended replacing the current exemption with a series of “safe harbors” specifically listing the practices that would be exempt from antitrust laws. Insurers and Congress have consistently recognized the pitfalls of the safe harbors approach. No matter how carefully drafted, safe harbors would prove inefficient in protecting current operations and would lack the flexibility to adapt to changing business practices.

The existence of the limited antitrust exemption makes the industry more competitive, not less. Congress should be wary of the unintended negative consequences of changes. Any change that discourages the exchange of advisory loss costs and supplementary rating information could place smaller and regional firms at a disadvantage, and harm consumers by increasing costs, reducing choice and seriously undermining competition. There is no credible evidence that the cost, availability or quality of insurance products would be enhanced if the antitrust exemption were repealed or modified, or if enforcement were shifted to the federal government.

Carl Parks is senior vice president for government affairs for the National Association of Mutual Insurance Companies. This is taken from NAMIC testimony on March 7 before the U.S. Senate Committee on the Judiciary hearing on The McCarran-Ferguson Act.