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Mr. Bob Hunter
June 20, 2006
THE MCCARRAN-FERGUSON ACT: IMPLICATIONS OF REPEALING THE
Good morning, Mr. Chairman and members of the Committee. Thank you for inviting me here today to discuss the need for the antitrust exemption of the McCarran-Ferguson Act.
The McCarran-Ferguson Act is a truly astounding piece of legislation. The Act takes two controversial steps:
1. it delegates the regulation of insurance entirely to the states without providing any guidelines or standards for the states to meet and without mandating any continuing
Allowing corporations to collude in pricing and other market activities results in higher costs for buyers. Since the antitrust exemption was enacted in 1945, study after study by the federal government has called for an end to it. Both business and consumer buyers of insurance
Since then, developments in the insurance industry have added additional urgency to the need for full repeal of the antitrust exemption:
? Anticompetitive behavior by the insurance industry has been a prime cause of the homeowners insurance crisis along America's coastlines.
CFA urges the Senate to repeal the antiquated, unnecessary and harmful insurance antitrust exemption for the benefit of the nation's insurance consumers. We estimate that
The history of the McCarran-Ferguson Act is replete with drama, from an industry flipflopping on who should regulate it to skillful lobbying and manipulation of Congressional processes in order to transform the bill's short antitrust moratorium into a permanent antitrust
In fact, the insurance industry has long-standing anti-competitive roots. In 1819, local associations were formed to control price competition. In 1866, the National Board of Fire Underwriters was created to control price at the national level, but states enacted anti-compact legislation to control price fixing.
This increased state regulatory activity led insurers to seek a federal approach to preempt the state system. In 1866 and 1868, bills were introduced in Congress to create a national bureau of insurance, but the insurer effort was unsuccessful. Failing in Congress, the industry shifted to
The case on which rode the industry's hope for court-initiated reform was Paul v. Virginia, 75 U.S. (8 Wall) 168 (1868). But the insurance industry's hopes were dashed when the Supreme Court ruled that states were not prohibited by the Commerce Clause from regulating
For the next 75 years, insurance regulation remained in the states, despite repeated insurance industry litigation seeking federal preemption. (Ironically, the industry would later adopt the Paul rationale to fend off enhanced federal scrutiny of its activities under the Sherman
Until 1944, state regulation of insurance was secure, based on the rationale that insurance was not interstate commerce. But that assumption was repudiated in the 1944 Supreme Court decision United States v. South-Eastern Underwriters Association. That case brought the insurance industry's swift return to Capitol Hill to seek exactly the opposite type of relief from what it had previously advocated for so long.
Three months after the Supreme Court denied a motion for rehearing in South-Eastern Underwriters, Senators McCarran and Ferguson introduced a bill that would become the Act
Within two weeks of the bill's introduction, and without holding any hearings on the new measure, the Senate had passed it and sent it to the House of Representatives. As it was sent over, the McCarran-Ferguson Act provided only a very limited moratorium during which the business of insurance would be exempt from the antitrust laws.
The House Judiciary Committee also approved the bill without holding a hearing. The House floor debate indicates that House Members believed the language of the original bill already comported perfectly with the Senate amendment's stated goal of creating a limited moratorium during which the Sherman and Clayton Acts would not apply to the business of insurance.
However, despite the clear intent of both houses not to grant a permanent antitrust exemption, the conference committee proceeded to drastically transform the limited moratorium into a permanent antitrust exemption for the insurance industry. The new language provided that
The House approved the conference report without debate. The sole expression of the House's intent regarding the conference report containing the new section 2(b) proviso is the statement of House managers of the conference, which indicates they intended only to provide for a moratorium, after which the antitrust laws would apply. The Senate, in contrast, debated the conference report for two days. After repeated assurances that the proviso was not intended to preclude application of the antitrust laws, the Senate passed the bill, and President Roosevelt
The legislative history shows that the Senate had a serious debate on the antitrust exemption, unlike the House. Senator Claude Pepper contended that the new conference language enabled the states to evade the federal antitrust laws by mere authorizing legislation.
Unfortunately, the courts construing the Act did not make these inferences. When presented with the question of what Congress meant by "regulated," the courts found no standard
The antitrust exemption has been studied on several occasions by federal authorities, each time with the determination that continued exemption was not warranted. For example:
? In 1977, when I was Federal Insurance Administrator under President Ford, the Justice Department concluded, "an alternative scheme of regulation, without McCarran Act antitrust protection, would be in the public interest."3
ATTORNEY GENERAL SPITZER'S FINDINGS
The nation was shocked when it learned that New York Attorney General Elliot Spitzer had uncovered remarkable levels of anticompetitive behavior involving the nation's largest insurance companies and brokers. The victims were the most sophisticated insurance consumers of all - major American corporations and other large buyers. Bid-rigging, kickbacks, hidden commissions and blatant conflicts of interest were uncovered. Attorney General Spitzer's
On the federal side, the antitrust exemption that exists in the McCarran-Ferguson Act (and that is modeled by many states) has been the most potent enabler of anticompetitive
The Spitzer investigation reveals how easily sophisticated buyers of insurance can be duped by brokers and insurers boldly acting in concert in a way to which they have become
WIDE RATE DISPARITY REVEALS WEAK COMPETITION IN INSURANCE
Consider the wide disparities in automobile insurance rate quotes that a thirty-five year old married man in Philadelphia with a clean driving record would receive.5 Allstate would quote as much as $12,493 for this coverage; Erie Insurance Exchange (an insurer with a better service
Some would say this wide range in price proves a competitive market. It does not. A disparity like this, where prices for the exact same person can vary by a multiple of five, reveals very weak competition in the market. In a truly competitive market, prices fall in a much narrower range around a market-clearing price at the equilibrium point of the supply/demand curve.
There are a number of important reasons why competition is weak in insurance. Several have to do with the consumer's ability to understand insurance:
1. Complex Legal Documents. Most products are able to be viewed, tested, "tires kicked" and so on. Insurance policies, however, are difficult for consumers to read and
2. Comparison Shopping is Difficult. Consumers must first understand what is in the policy to compare prices.
3. Policy Lag Time. Consumers pay a significant amount for a piece of paper that contains specific promises regarding actions that might be taken far into the future. The test of an insurance policy's usefulness may not arise for decades, when a claim arises.
4. Determining Service Quality is Very Difficult. Consumers must determine service quality at the time of purchase, but the level of service offered by insurers is usually unknown at the time a policy is bought. Some states have complaint ratio data that help consumers make purchase decisions, and the NAIC has made a national database available that should help, but service is not an easy factor to assess.
5. Financial Soundness is Hard to Assess. Consumers must determine the financial solidity of the insurance company. They can get information from A.M. Best and other
6. Pricing is Dismayingly Complex. Some insurers have many tiers of prices for similar consumers--as many as 25 tiers in some cases. Consumers also face an array of
7. Underwriting Denial. After all that, underwriting may result in the consumer being turned away.
Other impediments to competition rest in the market itself:
8. Mandated Purchase. Government or lending institutions often require insurance. Consumers who must buy insurance do not constitute a "free-market," but a captive market ripe for arbitrary insurance pricing. The demand is inelastic.
9. Producer Compensation is Unknown. Since many people are overwhelmed with insurance purchase decisions, they often go to an insurer or an agent and rely on them for the decision making process. Hidden commission arrangements may tempt agents to place insureds in the higher priced insurance companies. Contingency commissions may also bias an agent or broker's decision making process.
10. Incentives for Rampant Adverse Selection. Insurer profit can be maximized by refusing to insure classes of business (e.g., redlining) or by charging regressive prices. Profit can also be improved by offering kickbacks in some lines such as title and credit insurance.
11. Antitrust Exemption. Insurance is largely exempt from antitrust law under the provisions of the McCarran-Ferguson Act.
Compare shopping for insurance with shopping for a can of peas. When you shop for peas, you see the product and the unit price. All the choices are before you on the same shelf. At the checkout counter, no one asks where you live and then denies you the right to make a purchase. You can taste the quality as soon as you get home and it doesn't matter if the pea company goes broke or provides poor service. If you don't like peas at all, you need not buy any. By contrast, the complexity of insurance products and pricing structures makes it difficult for consumers to comparison shop. Unlike peas, which are a discretionary product, consumers absolutely require insurance products, whether as a condition of a mortgage, as a result of
There will always be a need for regulation of insurance since it requires the consumer to pay for a service today that is not delivered until later - often much later. Competition and regulation are not mutually exclusive. They seek the same ultimate goal: the lowest possible
Attorney General Spitzer has begun tackling the contingent commission problem and the House Financial Services Committee has begun exploring the abuses in the title insurance industry. Today, Mr. Chairman, we address the antitrust exemption.
COMPETITION CAN BE ENHANCED BY REPEAL OF THE ANTITRUST EXEMPTION
The insurance industry, as documented by its history recounted above, arose from cartel roots. For centuries, property/casualty insurers have used so-called "rating bureaus" to make rates for several insurance companies to use. Not many years ago, these bureaus required that
In recent years, the rate bureaus have stopped requiring the use of their rates or even preparing full rates because of lawsuits by state attorneys general after the last liability crisis was caused, in great part, by insurers sharply raising their prices to return to ISO rate levels in the mid-1980s. ISO is an insurance rate bureau or advisory organization. Historically, ISO was a
Today the rate bureaus still produce joint price guidance for the large preponderance of the rate. The rating bureaus start with historic data for these costs and then actuarially manipulate the data (through processes such as "trending" and "loss development") to determine
Legal experts testifying before the House Judiciary Committee in 1993 concluded that, absent McCarran-Ferguson's antitrust exemption, manipulation of historic loss data to project losses into the future would be illegal (whereas the simple collection and distribution of historic data itself would be legal). This is why there are no similar rate bureaus in other industries. For
It is clear that the rate bureaus7 still have a significant anti-competitive influence on insurance prices in America.
? The rate bureaus guide pricing with their loss cost/multiplier methods.
CURRENT EXAMPLES OF THE COLLUSIVE NATURE OF INSURANCE - HOME INSURANCE AVAILABILITY AND PRICING IN THE WAKE OF HURRICANE KATRINA
As an example of coordinated behavior that would end if antitrust laws applied fully to insurers, consider the current situation along America's coastlines. Hundreds of thousands of people are having their homeowners insurance policies cancelled and prices are skyrocketing. As to the decisions to non-renew, on May 9, 2006 the ISO President and CEO Frank J. Coyne signaled that the market is overexposed along the coastline of America. In the National
Insurers have started major pullbacks in the Gulf Coast in the wake of the ISO pronouncement. On May 12, 2006, Allstate announced it would drop 120,000 home and condo
Collusion appears to be involved in price increases along our nation's coastline as well. On March 23, 2006, Risk Management Solutions (RMS) announced that it was changing its hurricane model upon which homeowners and other property/ casualty insurance rates are based. RMS said that "increases to hurricane landfall frequencies in the company's U.S. hurricane model will increase modeled annualized insurance losses by 40% on average across the Gulf Coast, Florida and the Southeast, and by 25-30% in the Mid-Atlantic and Northeast coastal regions, relative to those derived using long-term 1900-2005 historical average hurricane frequencies." This means that the hurricane component of insurance rates will sharply rise,
The RMS action interjects politics into a process that should be based solely on sound science. In the aftermath of the unexpectedly high damage caused by Hurricane Andrew,
RMS has become the vehicle for collusive pricing. In its report on its new hurricane model, RMS states:
In developing the new medium-term five-year view of risk, RMS has taken counsel from representatives across the insurance industry in determining that future model output will be for a 'medium-term' five-year risk horizon.9
To determine what should be the explicit risk horizon of an RMS Cat model, opinions were solicited among the wider insurance industry from those who both use and apply the
It is clear from the release that insurance companies sought this move to higher rates. RMS's press release of March 23, 2006 states:
'Coming off back-to-back, extraordinarily active hurricane seasons, the market is looking for leadership. At RMS, we are taking a clear, unambiguous position that our clients
The "market" (the insurers) sought leadership (higher rates), so RMS was in a competitive bind. If it did not raise rates, the market would likely go to modelers who did. So RMS acted and the other modelers are following suit. According to the National Underwriter's Online Service (March 23, 2006): "Two other modeling vendors--Boston-based AIR Worldwide and Oakland, Calif.-based Eqecat--are also in the process of reworking their hurricane models."
It is shocking and unethical that scientists at these modeling firms, under pressure from insurers, appear to have completely changed their minds at the same time after over a decade of using models they assured the public were scientifically sound.
Insurers often try to position supposedly objective and independent third parties as the public decision-makers when it is insurers themselves who want to increase rates. For decades, the third parties that often performed this function were ratemaking (advisory) organizations
More recently, insurers have utilized new third party organizations (like RMS) to provide information (often from "black boxes" beyond state insurance department regulatory reach) for key insurance pricing and underwriting decisions, which helps insurers to avoid scrutiny for their actions. These organizations are not regulated by the state insurance departments and have a
INEFFICIENCY HARMS CONSUMERS
Because of market inefficiencies, exacerbated by the collusion allowed by the McCarran-Ferguson antitrust exemption, high expense insurers with commensurate high prices can charge whatever is needed to cover their inefficient operations or even more and, like Allstate in
Inefficiency abounds in insurance, as the attached spreadsheet reveals (Attachment B). If competition was more effective, significant cost savings (savings in the double digits) could be expected. The spreadsheet contains data compiled by AM Best and Co. showing expenses as a
The first three columns of numbers are the expenses for the entire industry. The spreadsheet shows, by major line of insurance, the loss adjustment expense and the underwriting expenses and the total of these two expense ratios. The loss adjustment expense is the cost of
The next three columns show similar data but for a specific efficient and large (at least one percent of the national premiums in the line of insurance shown) insurance company.
The final two columns are calculations made by CFA to show the potential savings if competition were enhanced. The first of the two columns shows the savings that would occur if the average expense ratio of all insurance companies were lowered to that ratio enjoyed by an
CFA believes that application of antitrust laws to the insurance industry could result in double-digit savings for America's insurance consumers of at least ten percent. Our study shows remarkable potential benefits for consumers if the antitrust exemption is removed and states do a better job of regulating insurers.
ELIMINATING THE ANTITRUST EXEMPTION HAS HELPED CONSUMERS IN
The proof that competition and regulation can work together in a market to benefit consumers and the industry is the manner in which California regulates auto insurance under Proposition 103. Indeed, that was the intent of the drafters of Proposition 103. Before Proposition 103, Californians had experienced significant price increases under a system of "open competition." Proposition 103 sought to maximize competition by eliminating the state
As our in-depth study of regulation by the states revealed,11 California's regulatory transformation - to rely on both maximum regulation and competition - has produced remarkable results for auto insurance consumers and for the insurance companies doing business there. The study reported that insurers realized very substantial profits, above the national average, while consumers saw the average price for auto insurance drop from $747.97 in 1989, the year Proposition 103 was implemented, to $717.98 in 1998. Meanwhile, the average premium rose nationally from $551.95 in 1989 to $704.32 in 1998. California's rank dropped from the third costliest state to the 20th.
I can update this information through 2003.12 As of 2003, the average annual premium in California was $821.11 (Rank 20) vs. $820.91 for the nation. Since California went from
Removing the antitrust exemption has been a key element in this successful transformation of California's insurance market.
I encourage you to carefully review materials from the last time Congress studied this matter: the hearings and report developed under Chairman Jack Brooks of the House Judiciary Committee in the early to mid 1990s. You will find that a long list of organizations supported reform: from labor to business, from consumer groups to the ABA.
In 1994, the House Judiciary Committee issued its report. A compromise proposal emerged after years of negotiation that both we at CFA and the American Insurance Association
That bill would have been a good step forward in 1994, so we agreed to the compromise. In the intervening years, we have had another hard market made possible by Congressional
Given these new outrages, CFA believes that the compromise we agreed to in 1994 would be too little, too late in 2006. We now believe that only a complete repeal of the antitrust exemption will achieve the reforms that are necessary to end these anticompetitive abuses.
Congress should end the long history of insurance industry collusion and anticompetitive behavior. This behavior routinely costs consumers more money than a competitive market would because insurers can cooperate in price setting. 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.
As insurers push for more pricing freedom, I always ask them where they stand on repeal of the McCarran-Ferguson antitrust exemption. It seems pretty obvious to me that it is folly to deregulate an industry with cartel structures still in place (I happen to believe that insurance is
Public and media support for ending this antitrust exemption has been quite strong for avery long time. Over the decades:
? Business Week editorialized that "The Insurance Cartel is Ripe for Busting."14
It is time to heed the advice of federal study after federal study. It is time to heed the advice of business consumers and simple American consumers. It is time to heed the call of editorial writers. It is time for Congress to repeal the antitrust exemption of the McCarran-
COLLUSIVE ACTIVITY BY THE INSURANCE SERVICES ORGANIZATION THAT IS ALLOWED BY THE MCCARRAN-FERGUSON ANTITRUST EXEMPTION
The ISO website has extensive information on the range of services they offer insurance companies. The website illustrates the deep involvement that this organization has in helping to set insurer rates, establishing policy forms, underwriting policies and in setting other rules.
? The page "The State Filing Handbook," promises 24/7 access to "procedures for adopting or modifying ISO's filings as the basis for your own rates, rules and forms."
Finally, ISO has a page describing "Advisory Prospective Loss Costs," which lays out the massive manipulations ISO makes to the historic data. A lengthy excerpt follows:
Your company can use ISO's estimates of future loss costs in making independent decisions about the prices you charge for your policies. For most property/casualty
"The insurance pricing problem -Unlike companies in other industries, you as a property/casualty insurer don't know the ultimate cost of the product you sell -- the insurance policy -- at the time of sale. At that time, losses under the policy have not yet occurred. It may take months or years after the policy expires before you learn about,
"Loss development ...because it takes time to learn about, settle, and pay claims, the most recent data is always incomplete. Therefore, ISO uses a process called loss
"Loss-adjustment expenses - In addition to paying claims, your company must also pay a variety of expenses related to settling the claims. Those include legal-defense
"Trend -Losses adjusted by loss-development factors and loaded to include lossadjustment expenses give the best estimates of the costs insurers will ultimately pay for
"What you get - With ISO's advisory prospective loss costs, you get solid data that you can use in determining your prices by coverage, state, territory, class, policy limit, deductible, and many other categories. You get estimates based on the largest, most credible set of insurance statistics in the world. And you get the benefit of ISO's renowned team of actuaries and other insurance professionals. ISO has a staff of more than 200 actuarial personnel -- including about 50 members of the Casualty Actuarial Society. And no organization anywhere has more experience and expertise in collecting and managing data and estimating future losses."
ISO's activities extensively interfere with the competitive market, a situation allowed by the provisions of the McCarran-Ferguson Act's extensive antitrust exemption.
1 One segment of the industry seeks an optional federal charter for inusrance. A second segment seeks federal preemption of state consumer protections. A third segment of the industry supports the status quo. Both industry-