Ultimate Effects of McCarran-Ferguson Federal Antitrust Exemption
on Insurer Activity are Unclear (28-JUL-05, GAO-05-816R).	 
                                                                 
This letter transmits our briefing slides describing the	 
potential effects of the federal antitrust exemption included in 
the McCarran-Ferguson Act (McCarran) on insurer activities. On	 
May 26, 2005, we briefed Congressional staff on the results of	 
our review. Specifically, we assessed existing insurance	 
practices that might violate federal antitrust law absent the	 
McCarran exemption and identified current state authorities	 
related to antitrust laws applicable to insurance. In a separate 
GAO legal opinion, Legal Principles Defining the Scope of the	 
Federal Antitrust Exemption for Insurance, published in March	 
2005, we assessed the types of insurance-related activities that 
courts have found to be exempt from federal antitrust provisions 
under the McCarran exemption.					 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-05-816R					        
    ACCNO:   A31418						        
  TITLE:     Ultimate Effects of McCarran-Ferguson Federal Antitrust  
Exemption on Insurer Activity are Unclear			 
     DATE:   07/28/2005 
  SUBJECT:   Antitrust law					 
	     Federal law					 
	     Future budget projections				 
	     Insurance companies				 
	     Insurance losses					 
	     Insurance regulation				 
	     Law enforcement					 
	     Tax exempt status					 
	     Insurance premiums 				 

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GAO-05-816R

United States Government Accountability Office Washington, DC 20548

July 28, 2005

The Honorable Michael G. Oxley
Chairman
Committee on Financial Services
House of Representatives

Subject: Ultimate Effects of McCarran-Ferguson Federal Antitrust Exemption
on Insurer Activity are Unclear

This letter transmits to you our briefing slides describing the potential
effects of the federal antitrust exemption included in the
McCarran-Ferguson Act (McCarran)1 on insurer activities. On May 26, 2005,
we briefed committee staff on the results of our review. Specifically, we
assessed existing insurance practices that might violate federal antitrust
law absent the McCarran exemption and identified current state authorities
related to antitrust laws applicable to insurance. In a separate GAO legal
opinion, Legal Principles Defining the Scope of the Federal Antitrust
Exemption for Insurance, published in March 2005, we assessed the types of
insurance-related activities that courts have found to be exempt from
federal antitrust provisions under

2

the McCarran exemption.

We focused our analysis on property/casualty insurance, including workers
compensation, because insurers in these areas participate in many joint
activities. We consulted relevant literature, including prior
congressional and state hearings on the topic, and met with experts from
state insurance departments, attorneys general offices, insurance
companies, trade associations, rating organizations, law firms, and
academia. We met with knowledgeable staff at the National Association of
Insurance Commissioners, the Department of Justice, and the Federal Trade
Commission. We limited our review of states' insurance regulation and
antitrust authorities to five states with large insurance markets that had
varying degrees of rate regulation and differences in state antitrust
exemptions-California, Illinois, New Jersey, New York, and Texas. We
conducted our work from February 2005 through July 2005 in accordance with
generally accepted government auditing standards.

1Pub. L. No. 79-15, ch. 20, 59 Stat. 33, codified as amended at 15 U.S.C.
S:S: 1011-1015.

2GAO, Legal Principles Defining the Scope of the Federal Antitrust
Exemption for Insurance, B304474 (Washington, DC: March 4, 2005).

           GAO-05-816R McCarran-Ferguson Federal Antitrust Exemption

Background

Congress passed the McCarran-Ferguson Act (McCarran) in 1945, following a
Supreme Court decision that determined that insurance is interstate
commerce which

3

Congress could regulate and subject to federal antitrust laws. McCarran
reaffirmed the power of the states to regulate and tax insurance companies
and exempted certain insurance practices from federal antitrust laws,
including the Sherman, Clayton, and Federal Trade Commission Acts. The
insurance exemption applies to those activities that (a) constitute the
"business of insurance;" (b) are "regulated by State law;" and (c) do not
constitute an agreement or act "to boycott, coerce, or intimidate." Our
legal opinion discusses court decisions concerning the types of activities
covered by the exemption. Among other things, the courts have found that,
generally speaking, joint rate-making among property/casualty insurers is
the "business of insurance" and thus exempt from federal antitrust laws
under McCarran.

Besides McCarran, there are other, more general sources of immunity from
federal antitrust laws, including the state action doctrine and the
Noerr-Pennington Doctrine. The state action doctrine allows for
anticompetitive conduct provided that the conduct is both (a) part of a
clearly articulated policy by a state to displace competition in a
regulated area and (b) actively supervised by state regulators with
statutory authority to review the conduct. The Noerr-Pennington Doctrine
provides immunity for certain joint efforts by competitors to petition the
government. Both of these immunities may be applicable to insurance.
States also have their own antitrust authorities, which may or may not
include exemptions for insurance.

Effects of McCarran Exemption Uncertain, but without the Exemption Some
Insurer Activities Could Raise Antitrust Concerns

Because the courts have not considered which activities within the
"business of insurance" might violate federal antitrust laws, it is
difficult to determine which insurer activities would withstand antitrust
scrutiny if the exemption were removed. Decisions involving antitrust law
are typically based on the facts and circumstances of each case. With
insurance activities, if the court decides that the McCarran exemption
applies, it generally conducts no further analysis of the activities.
Unsure about how courts would decide insurance cases, when eliminating or
proposing to eliminate antitrust immunities, legislators at both the state
and federal levels have included "safe harbors" for certain insurance
activities such as the collection of

4

historical data.

Some experts have suggested that absent the McCarran exemption, activities
in the property/casualty area, especially joint rate-making, might violate
federal antitrust

3See United States v. Southeastern-Underwriters Ass'n, 322 U.S. 533
(1944).

4California's Proposition 103, codified at Cal. Ins. Code S:S: 1861 et
seq., had "safe harbors" embedded in its repeal of the state antitrust
exemption for insurance, and congressional proposals to modify the
McCarran exemption under the Insurance Competitive Pricing Act of 1994,
H.R. 9, as amended, 103d Congress (1994), also carved out certain
activities to avoid further litigation in these areas.

          2 GAO-05-816R McCarran-Ferguson Federal Antitrust Exemption

laws, citing concerns over the collective projection of insurer losses
into the future. To price insurance policies, property/casualty insurers
need to project loss costs- the amount insurers use to cover claims and
the costs of adjusting those claims-into the future. Projecting loss costs
requires large amounts of data on historical losses and actuarial
expertise, and single insurers are not likely to have sufficient data or
expertise in all of the insurance lines they sell. Thus, for a significant
portion of rate

5

making, property/casualty insurers rely on rating organizations. Rating
organizations standardize risk classifications and products to facilitate
the gathering and aggregation of data on past losses and their costs.
Then, they bring this historical data up to the present by estimating loss
costs for events that have occurred but have not yet been reported.
Finally, rating organizations issue "advisory prospective loss costs" by
projecting loss costs into the future. They do this by trending-analyzing
past data trends and using actuarial judgment about the future.

According to industry representatives, regulators, and other experts, this
rate-making process has certain benefits, but also raises antitrust
concerns. Generally, they believe the process reduces the costs associated
with pricing and regulating insurance, makes it easier for new firms to
enter the insurance market, and allows consumers to better compare
products. However, some experts believe that under some circumstances
joint trending might constitute price fixing absent the McCarran
exemption, and that standardized risk classifications and products might
restrict new insurers or products from entering the market, thus limiting
innovation, consumer choice, and competition. Further, according to most
experts, courts are more likely to find joint trending a violation of
federal antitrust laws than the joint collection of historical data.

For some, the McCarran exemption raises the issue of insurance industry
uniqueness-that is, whether insurance warrants a federal antitrust
exemption that most other industries do not have. Some industry
representatives said that insurance is different from other industries
because when it is sold the insurer does not know what the cost of a
policy will be. In addition, insurer insolvencies can pose significant
social costs. Some state regulators told us that lack of certainty about
future costs leads some insurers to underestimate their future costs and
significantly underprice their policies, potentially leading to costly
insolvencies. They said that joint ratemaking provides more information
and greater certainty to insurers. Other experts have suggested that
insurance is not unique and that other industries-such as banking- face
uncertainty about future costs, but do not have antitrust immunity.

5States authorize rating organizations, sometimes called statistical or
advisory organizations, to assist in the rate-making process. Nationally,
two of the largest rating organizations are the Insurance Services Office
in personal and commercial lines and National Council on Compensation
Insurance in workers compensation.

          3 GAO-05-816R McCarran-Ferguson Federal Antitrust Exemption

Application of State Antitrust Authorities to Insurance Varied Across the
Five States We Visited

Although insurance is immune from federal antitrust laws, insurers in the
states we visited were subject to state antitrust and related authorities
to varying extents. In New York, property/casualty insurers' rate-making
activities are exempt from the state antitrust laws, but the insurance
code prohibits insurers from participating in unfair methods of
competition. In Texas, where certain other regulated industries have
exemptions, insurance has no general antitrust immunity. California and
New Jersey both had periods of time in the late 1980s and 1990s when they
prohibited

                                       6

insurers from joint trending in some lines of insurance. However, state
officials do
not view these periods as valid experiments of how an insurance market
would
behave absent McCarran because of other factors influencing the market at
that time.
In addition, we also found that all five states had some provisions in
their codes to
prohibit insurers from engaging in unfair or deceptive acts or practices
in their states.
The states we visited also regulated property/casualty insurance rates to
varying
degrees. For example, California requires prior approval for many of its
rates, while
Illinois relies on the market to determine most rates. The degree of state
rate
regulation could have significant effects on the applicability of federal
antitrust laws
to insurance if the McCarran exemption were amended or repealed. In those
states
that actively regulate and enforce rates, insurers might seek and might be
granted
immunity from federal antitrust laws under the state action doctrine in
the absence
of the McCarran exemption.

As agreed with your office, unless you publicly announce its contents
earlier, we plan
no further distribution of this report until 30 days after its date. At
that time, we will
send copies of this report to the Chairman and Ranking Minority Member of
the
Senate Committee on Banking, Housing, and Urban Affairs and the Ranking
Minority
Member of the House Committee on Financial Services. We will also make
copies of
this report available to other interested parties and others upon request.
In addition,
it will be available on GAO's home page at http://www.gao.gov. If you or
your staff
have questions regarding this report, please contact me at (202)-512-8678
or
[email protected]. Contact points for our Offices of Congressional
Relations and
Public Affairs may be found on the last page of this report. Lawrence D.
Cluff, Nancy
S. Barry, Katherine C. Bittinger, and Tania L. Calhoun made key
contributions to this
report.

Sincerely yours,

Richard J. Hillman
Director, Financial Markets and Community Investment

Enclosure

6In New Jersey, the state passed legislative changes only for the personal
auto market.

          4 GAO-05-816R McCarran-Ferguson Federal Antitrust Exemption

(250229)
30 GAO-05-816R McCarran-Ferguson Federal Antitrust Exemption

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