Due to its central role in United States society (see Section 11.01), it is settled public policy that insurance is a heavily regulated industry. However, what constitutes efficient and effective regulation of this commercial enterprise constitutes a subject of vigorous debate.
National debate tends to focus on a structural question: whether the industry should be federally regulated. This current debate needs to be placed in the intriguing historical context of insurance regulation in this nation. Section 11.02 discusses salient points in this history. Under the McCarran-Ferguson Act of 1945 the states solely regulate this large sector of interstate commerce. Often ignored, however, is the inextricable link between this unique structure and the unusual substance of insurance regulation — including state regulation of price and the basic relationship between buyers and sellers in a competitive market. These can only be understood by specific and detailed reference to a historic interaction between the United States Supreme Court and Congress during a nine-month period during the height of the Second World War.
State price fixing statutes — originally developed on an ad hoc basis during the early Twentieth Century as a mechanism to bolster solvency through rate adequacy—were codified along with a limited antitrust exemption as national insurance regulatory policy by Congress in the McCarran-Ferguson Act in March, 1945, after the Supreme Court’s landmark decision of June, 1944, in U.S. v. South-Eastern Underwriters Ass’n. South-Eastern Underwriters overruled nearly 76 years of the Court’s own precedent where insurance had been held not to be interstate commerce and thus (a) subject only to state regulation and (b) exempt from the Sherman Antitrust Act.
The longevity of the primacy of state regulation of a significant sector of interstate commerce has proven to be an ironic result of South-Eastern Underwriters. The Court’s opinion — positioning state regulation as a Constitutional aberration — destroyed the basis for the established state insurance regulatory system by subjecting it to crippling Dormant Commerce Clause challenges. This decision forced Congress to pass the McCarran-Ferguson Act where Congress opted to forgo creating a national regulatory framework. On a timetable under which no Congress — let alone one supervising the largest foreign war in American history — could legislate, Congress made the only viable policy choice available and established what has proven to be an overwhelming inertia for state regulation. The Court’s lack of appreciation of the practical subtleties of its Constitutional relationship with Congress was exposed in a partial dissent by Justice Jackson.
Jackson, while agreeing that insurance was interstate commerce advocated that the Court tell Congress that its prior holdings regarding the Commerce Clause’s application to insurance were wrongly decided — but without overruling them. Instead, he would have temporarily and explicitly sustained this legal fiction while inviting Congress to legislate — deliberately and thoroughly — to federalize insurance regulation.
Without this option, Congress responded by taking the minimalist route of quickly delegating the day-to-day responsibilities of insurance regulation back to the states, while creating a limited antitrust exemption dependent on state price controls. Since the McCarran-Ferguson Act of 1945, the inertia of that policy choice has stuck, leading to precisely the opposite result which the majority opinion in South-Eastern Underwriters intended.
Along with the structure of state oversight, the substance of McCarran-era insurance regulation has largely survived intact, but with a twist: State rate regulatory laws have morphed from a solvency tool (which depend on keeping rates up) to an affordability prod (designed to keep rates down)—leading to government price controls in the competitive marketplaces of automobile and homeowner’s insurance.
The rate regulation laws (discussed in Section 11.02) are part of a comprehensive regulatory scheme which suppresses normal competitive forces and which also includes restrictions on risk classification and bargaining between buyers and sellers.
Unfair discrimination laws are the subject of Section 11.03. These laws govern the manner in which insurers classify consumers with shared characteristics and group policyholders according to risk. The core state insurance discrimination laws hold that like risks must be treated alike: Risk classification decisions must be actuarially justified. Legislatures often graft social policy choices upon this system by creating protected classes which cannot be used to classify risk regardless of actuarial justification. The consensus protected classes of race, national origin, and religion are uncontroversial.
Important policy debates pertaining to other actuarially justified risk factors have become a significant flashpoint in insurance regulation today. Insurers in recent years have utilized advances in computation technology to create predictive models which are far more sophisticated in predicting future losses. This numerical precision raises new political challenges, however, as consumer groups, regulators, and legislators question the equity of some of these tools, such as the use of consumer credit information, education and occupation in insurance risk scoring models. These policy debates raise fundamental questions about the purpose of the regulatory state, the fairness of risk-based underwriting and rating, and the proper degree of government control over commerce.
Section 11.04 examines anti-rebating laws. These laws are not well known and are relatively insignificant in political debate — but at the same time are highly anti-competitive. The vast majority of states prohibit insurers and agents from cutting prices and commissions or offering any other consideration (not specified in the contract, which is filed with and approved by the state) to consumers as inducement to purchase insurance. This makes the basic act of bargaining back and forth between seller and buyer, so fundamental to capitalism, illegal in the business of insurance, and serves to close the web of government control over the most basic elements of the insurance transaction.
Nathaniel S. Shapo is a partner in the Litigation and Dispute Resolution Practice and Co-Chair of the Insurance Capital Markets Practice of Katten Muchin Rosenman LLP as well as Lecturer in Law at the University of Chicago Law School. Mr. Shapo served four years as director of the Illinois Department of Insurance where he consulted with Congress and federal bank regulators on the Gramm-Leach-Bliley (Financial Services Modernization) Act and helped draft the National Association of Insurance Commissioners (NAIC) Statement of Intent for the Future of Insurance Regulation. Mr. Shapo was elected to the NAIC Executive Committee four times: twice as a national officer (as secretary-treasurer and vice president) and twice as chair of the NAIC Midwestern Zone.