Federal Insurance Antitrust Exemption: Insurer, Consumer Friend or Foe?

Congress opened a fresh debate on the insurance industry’s exemption from federal antitrust laws this week, with some larger insurers indicating a willingness to relinquish the exemption in exchange for regulatory reform that would free them from state regulation.

At the same time, the industry’s biggest rating organization that operates under the exemption argued that its services save typical and smaller insurers and therefore consumers millions of dollars a year and a national consumer group estimated that elimination of the exemption would save insurance consumers about at least 10 percent of the current premiums, or about $45 billion a year.

The U.S. Senate Judiciary Committee heard testimony this week on whether to continue the limited insurance antitrust exemption contained in the 1945 McCarran Ferguson Act, which placed responsibility for insurance regulation with the states and has permitted insurers to engage in certain joint data collection, price trending and form and policy development activities. The law makes possible rating organizations such as Insurance Services Office, the National Council on Compensation Insurance and the American Association of Insurance Services.

Kevin B. Thompson, senior vice president with Insurance Services Office, Inc. (ISO), told lawmakers that insurers’ access to advisory organization materials “deserves to be preserved and protected.” He warned that “[s]ince repeal or substantial modification of the McCarran-Ferguson Act’s limited antitrust exemption is likely to create legal uncertainty and have a chilling effect on legitimate insurer use of those materials, no change should be considered without proof that it is needed and that it will help, not harm competition in the property/casualty insurance business.”

He argued that ISO’s products and services reduce an insurer’s operating costs by providing information and services that an insurer needs to write business at relatively lower costs than would be possible using its own resources. “Without the availability of ISO’s materials many insurers would have to increase staffing substantially and invest in expensive equipment, significantly increasing costs. In a competitive insurance market, lower costs of doing business translate into lower prices for consumers,” he maintained.

He testified that if every insurer had to incur even a fraction of the total ISO cost for providing these services, “it would have a significant impact on each insurer’s ability to stay in or enter many markets.”

The ISO executive estimated that a typical insurer operating in 25 states with an annual general liability insurance premium volume of $50,000,000 pays approximately $75,000 a year for all of ISO’s general liability prospective loss costs, rules and forms, which is less than two tenths of one cent for every dollar of general liability premium the insurer writes. Yet for just one line of insurance, it cost ISO more than $11 million in 2005 to produce those products, he stated. If this insurer achieved the average profit margin for the five years ending 2004, it would have netted nearly $4.4 million. “All that profit would have been eaten away if that average insurer incurred expenses approaching only part of ISO’s costs to replicate the processes ISO performs,” he concluded.

Many insurers, especially smaller ones, do not generate enough of their own loss information to predict expected costs reliably, according to ISO. Also, he maintained that ISO’s information permits insurers to be more confident in making pricing decisions, which means less margin for error can be built into rates, leading to lower premiums.

However, by using ISO’s products and services small insurers can compete with large ones and large insurers can do business in places in which they have low premium volume or no business at all. Insurance consumers are the beneficiaries when there are many insurers competing to gain market share, Thompson continued.

Finally, he argued that ISO’s common policy form language facilitates comparison shopping by policyholders and their agents and supplies “legal certainty” to reduce the likelihood that the same issues will be litigated time and again.

While ISO tried to point out the benefits, other insurers were providing only conditional support of the antitrust exemption.

Marc Racicot, president of the American Insurance Association (AIA), maintained that a repeal or limitation of McCarran’s antitrust provisions “cannot be divorced” from a discussion of state insurance regulation.

“Repeal of McCarran might impact legitimate information gathering undertaken pursuant to state law and regulation, thus undercutting the ability of the states to decide the types of information they want to allow insurers to collect, share and analyze under state supervision. As a result, a repeal of McCarran cannot be justified as a matter of law. Nor would it be sound public policy,” the AIA chief testified.

However, if Congress were to shift regulation of the industry from the states to Washington, the federal antitrust exemption would take on new meaning. Racicot’s organization supports the National Insurance Act of 2006, which would allow insurers – as well as insurance agents and brokers – to opt into a federal regulatory system. S. 2509 would dispense with state government price controls in favor of price competition among insurers.

Racicot explained how S.2509 would alter McCarran’s effect. “Since the McCarran-Ferguson Act only applies to the business of insurance regulated by the states, it obviously would not apply to pricing activities of federally chartered insurers operating under federal law. Therefore, federal antitrust laws would apply to federally-chartered insurers under S. 2509 to the extent that the states no longer regulate their activities.”

Racicot told the Senate committee that his group’s members are “willing to take the risks inherent in this approach on the antitrust side because we so strongly believe that a competitive market, without government rate and price controls, is critical to being able to serve their customers in the years ahead.”

AIA member companies are willing to open themselves to federal antitrust law as part of the price for being freed from state regulation.

“Thus, we are willing to shift McCarran’s current balance between regulatory supervision and antitrust policy to one that reduces the role of regulation and returns that role to the federal government, and increases the role of the federal antitrust laws. However, we do not believe it is appropriate to repeal McCarran-Ferguson in the context of insurance pricing without initiating the paradigm shift that would result from S. 2509,” Racicot explained.

One public prosecutor took a different approach, asking Congress to reexamine McCarran because she said it gets in the way of effective antitrust enforcement.

Elinor Hoffmann, assistant attorney general from the Office of the Attorney General for New York, cited her department’s investigations of bid-rigging and questionable brokerage fees. She said that had her boss, N.Y. Attorney General Eliot Spitzer, prosecuted these cases under federal antitrust law, the McCarran-Ferguson Act likely would have delayed, or maybe precluded, settlement.

“A uniform federal antitrust standard would facilitate antitrust enforcement and benefit plaintiffs and defendants alike, in contrast to disparate actions, under different laws, that may yield inconsistent results,” she told the Senate panel, adding, “This is not just a New York State problem: it is a pervasive national problem.”

Hoffmann said the McCarran-Ferguson exemption “precludes federal antitrust enforcement of serious anticompetitive conduct” in insurance, and requires state enforcement agencies to examine each state’s laws on antitrust activity because states vary in their antitrust approaches. Also, remedies and outcomes may differ from state to state.

Hoffmann further maintained that repeal of the exemption should not require preemption of state regulatory systems, which deal with more than antitrust policy, and are “consistent with a preference for competition in this critical sector of the nation’s economy.”

While Hoffman endorsed repeal of the McCarran Act as it is now written, she also urged Congress to heed any particular requirements of the insurance industry and carve out provisions to save certain activities from antitrust restrictions if necessary.

“It may be necessary, for example, to include targeted savings clauses in the legislation to enable insurers to participate in joint underwriting agreements and ancillary activities in a manner that does not restrain competition, and to cooperate in developing standards that would enhance consumer understanding of their insurance policies, such as standards for plain language and simplified forms for insurance policies,” the New York official stated.

Finally, she added, because state regulation of insurance is complex and reaches far beyond the concerns of antitrust law, state regulation should not be pre-empted. By the same token, state regulation should not exempt insurers from the federal antitrust laws.

The argument for complete repeal came from J. Robert Hunter, director of Insurance for the Consumer Federation of America, who termed the McCarran-Ferguson Act “a truly astounding piece of legislation” not only because it exempts insurers from antitrust laws but also because it omits any oversight by the federal government of state regulation.

CFA estimate that elimination of the exemption would save insurance consumers at least 10 percent of the current premiums, or about $45 billion a year.

“CFA urges the Senate to repeal the antiquated, unnecessary and harmful insurance antitrust exemption for the benefit of the nation’s insurance consumers,” Hunter testified.

He maintained that “anticompetitive behavior has been a prime cause” of a homeowners insurance crisis along America’s coastlines. Also, state attorneys general have had to jump in to stop bid-rigging, market allocation arrangements and hidden kickbacks to brokers because state regulators failed to act.

He argued that organizations such as ISO restrain competition “significantly” since they make “loss costs,” which represent about 60-70 percent of the rate; share expense data so insurers can compare their costs, and establish classes of risk that are adopted by many insurers.

“The business cycle of the property/casualty insurance industry is exacerbated by the availability of pure premium and other rate guides the rate bureaus publish. These guides are not used by many insurers during the ‘soft’ market periods but become a kind of safe harbor when the periodic hard market strikes the commercial property/casualty market,” Hunter added.

That’s not all that’s wrong with rating bureaus, according to Hunter. “Rate bureaus, of course, must bias their projections to the high side to be sure that the resulting rates or loss costs are high enough to cover the needs of the least efficient, worst underwriting insurer member or subscriber to the service,” he said.

He also criticized rate bureaus — and hurricane modeling firms — for public comments he said signal to insurers when the time is right to raise prices. He suggested such signals have contributed to hundreds of thousands of coastal residents having their homeowners insurance policies cancelled and sent prices skyrocketing.

To bolster his case for repeal, Hunter claimed that California’s Proposition 103, which eliminated the state antitrust exemption, “has produced remarkable results for auto insurance consumers and for the insurance companies doing business there. “

Senator Patrick Leahy, D-Vt., ranking member on the committee, used the opportunity to tout his S. 1525, The Medical Malpractice Insurance Antitrust Act of 2005. This bill would repeal the antitrust exemption for medical malpractice insurance only.

“It is a narrow bill that targets a particularly troublesome aspect of the problem, but I believe that we should consider all of the effects of the exemption as we consider legislation,” he said in his statement.