Time to Revisit State-Based Regulation?

This is not a question of which oversight is more appropriate, federal or state, but whether the status quo should be allowed to continue.

The states do not have a constitutional “right” to oversee insurance. Clearly, insurance and reinsurance is interstate commerce, which gives federal government the oversight. There are no states rights issues involved. The McCarran–Ferguson Act, 15 U.S.C. §§ 1011-1015, which was passed by Congress in 1945, does not regulate insurance, nor does it mandate the state regulation of insurance. Section 2(b) of the act does specify that the business of insurance is exempt from the antitrust laws only if it is regulated by the states. It provides that "Acts of Congress" that do not expressly regulate the "business of insurance" will not preempt state laws or regulations that regulate the "business of insurance." What else was going on in 1945? Oh, yeah, that World War II thing. Perhaps congress then did not want more responsibility. It is time that this war-generated act is revisited. "Perfunctory" would be a kind word for how some of the states actually oversee the insurance process. I have personally experienced insurance departments that are totally unaware of the laws by which they are supposed to be regulating insurance. Regulators either do not know the law or do not care about enforcing it. While I have not witnessed the federal government’s efficiency, to continue the regulatory status quo is to argue that the demonstrated 50-plus (states and territories) individual messes are better than one big mess, while having to accept as a foregone conclusion that a federal system would be a mess. The states have clearly proven to be lacking in both integrity and self-restraint. The 2015 State Integrity Investigation shows the reality of the situation. Only three states score higher than D-plus; 11 states flunked. The State Integrity Investigation is an in-depth collaboration designed to assess transparency, accountability, ethics and oversight in state government, spotlight the states that are doing things right and expose practices that undermine trust in state capitals. The project is not a measure of corruption, but of state governments’ overall accountability and transparency. The investigation looks at both the laws in place and the “in practice” implementation of those laws to assess the systems that are meant to prevent corruption and expose it when it does occur. State foxes are guarding the henhouse. While the state insurance regulatory heads are adamant about keeping their perfunctory regulation of insurance based on the misnomer of “states’ rights,” they are by design or defect giving away that power to the quasi-private nongovernmental National Association of Insurance Commissioners (NAIC) or the private rating agencies, which may be thought of as shadow regulators. In the name of commonality of law among the states, the NAIC produces model legislation, which the states are pressured to accept, lest they lose their cherished accreditation status by the NAIC. See also: How to Bulletproof Regulatory Risk   The tactic used by the NAIC is not unlike the federal speed limit of 55 MPH in the '70s and '80s. Where does the federal government have the right to tell any state what its speed limit should be? It doesn’t. But the Transportation Department said, Do this, or we won’t give you any highway funds. So how does this NAIC model legislation thing work? Here is an example. In the NAIC’s Deceptive Trade Practices Act (DTPA) or (Unfair Trade Practices Act), the NAIC said that if a company does something (bad) with regularity, that may be considered a “trade practice.” Originally, this was NOT anything but additional ammunition for the state insurance regulator, but when Texas passed this model, it did so with two big changes:
  1. A one-time act of bad by the insurance company could be considered a trade practice.
  2. There was a private right of action against the insurance company for violating the DTPA -- the right didn't just belong to the insurance regulator.
Oklahoma passed the act close to the way the NAIC wrote it, yet according to the NAIC both states have passed the model. But sameness in name does not mean sameness in fact. Fighting Back: Not everyone sees this drift toward private oversight as a good thing for the insurance consumer. The National Conference of Insurance Legislators (NCOIL) -- those elected guys who actually pass the insurance legislation -- are trying to do something about the drift. At its fall meeting in November 2015, NCOIL urged each state legislature, the departments of insurance and insurance commissioners to foster competition in insurer rating. No single insurer rating agency should be allowed to position itself to supersede state regulation. The message is clear; the state is in charge of insurance regulation, not some private rating agency setting up rules as to what an insurance company must do to get a certain grade. Major intermediaries appear to favor state oversight, which is logical because reinsurance intermediaries are basically unregulated by the various states, and they are not so likely to remain unregulated if the federal government assumes its rightful place in insurance regulation. Thomas B. Considine, now NCOIL’s chief executive but previously commissioner of the New Jersey Department of Banking and Insurance, used NCOIL’s spring meeting in New Orleans as the venue to raise public concerns about states becoming subject to the authority of the NAIC, a private trade association composed of the nation’s insurance regulators. The circumstance under which lawmaking authority may be delegated to private organizations is narrow. For that reason, delegation of states' authority to a private organization (such as the NAIC) needs to be stopped. The situation makes a good argument for the Treasury Department’s Federal Insurance Office, an agency whose existence has been questioned by the NAIC, as well as some other elements of the industry. State oversight is not a good argument against federal oversight, especially when the state regulator is doing what it can to cede its power to the private industry and away from itself. See also: Investment Oversight: Look Beyond Scores!   Bigger issue This is not just a turf war; it goes to the very core of the McCarran Ferguson Act itself. An analysis of the act will determine the scope of the antitrust exemptions. History paints a narrow picture. Issues are not centered on whether Congress has the power to regulate the business of insurance but rather whether the commerce clause precludes state regulation altogether. That changes the argument and the analysis. This is also not a case of which oversight is more appropriate, federal or state, but whether the state should be allowed to continue its oversight in order for various federal exemptions to apply to the entities in the business of insurance. That is, the Sherman, Clayton, and Federal Trade Commission (antitrust laws) apply to insurance only “to the extent that such business is not regulated by state law.” If states regulate, then exemptions apply; if the states do not regulate, the exemptions do not apply. This is a very clear indication that any dismissive perfunctory attitude of some state regulators invites the application of federal law against those in the business of insurance. Analysis
  1. Is the activity part of the business of insurance? (Unfortunately, the act does not define the business of insurance, and the legislative history here is not clear.)
  2. If it is, then the analysis goes to the extent to which the activity is regulated by the state. § 2 (b) of the McCarran -Ferguson Act addresses the state regulation activity. (Case law shows that any uncertainty regarding the applicability of the exemption should be resolved against a grant of antitrust immunity.) Unfortunately, the U.S. Supreme Court has not defined what extent is necessary; however, lower courts hold that a statutory framework that is a mere pretense is insufficient. Perfunctory regulation won’t suffice. The legislative history indicates that Congress intended the exemption only when effective state law exists.
  3. If the activity is not regulated effectively by the state, or if the activity constitutes a form of boycott, coercion or intimidation, the activity will be subject to the scrutiny of the antitrust laws.
The wholesale delegation of authority by the various states to the NAIC or deferring to select private rating agencies brings with it the very real possibility of a successful challenge to the state’s current insurance regulatory status quo.

Bruce Heffner

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Bruce Heffner

Bruce Heffner is general counsel and managing member for Boomerang Recoveries. He is an attorney with substantial business experience in insurance and reinsurance, underwriting, claims, risk management, corporate management, auditing, administration and regulation.


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