Much political hay has been made of late over the McCarran-Ferguson Act, which is commonly but wrongly dubbed the “antitrust exemption” for insurers. Past efforts have been made to repeal McCarran-Ferguson entirely (Patrick Leahy is big on this), but the latest incarnation, H.R. 3596, would make piecemeal changes to the Act for health and medical malpractice insurance only. Decent arguments can be made pro and con, but for reasons that don’t lend themselves to sound bites, few of them are.

First, a little background. Of all the financial industries in the country, insurance is the one that has never been regulated by the federal government and, not necessarily by coincidence, the only one that hasn’t crashed and burned in recent years. A.I.G. is actually the exception that proves the rule, as their downfall was caused not by their insurance subsidiaries, which remain solvent to this day, but by its Financial Products Division, which issued credit default swaps. CDS have an insurance-like attribute, in that they pay out in the event of a fortuitous event (in this case, a mortgagor’s default on a note), but differ from insurance in that the holder of the CDS need not have an insurable interest in the subject of the loss. In that respect, CDS are really more like gambling than traditional insurance, akin to me buying an “insurance” policy to “protect” me against the risk that your house burns down. So why did the states drop the ball on CDS while successfully regulating actual insurance? Glad you asked: because the misguided Commodities and Futures Modernization Act of 2000 preempted the states from regulating CDS as either insurance (which they weren’t) or gambling (which they were).

The reasons for the federal government’s lack of regulation in insurance are largely historical. For more than half of the nation’s existence, Congress’s power to regulate under the Commerce Clause was strictly limited. In Paul v. Virginia, 75 U.S. 168 (1868), the U.S. Supreme Court goofily ruled that issuing an insurance policy was “not a transaction of commerce,” and was therefore beyond Congress’s reach under the Commerce Clause. Seventy-odd years later, in Wickard v. Filburn, 317 U.S. 111 (1942), the Court went to the opposite extreme and ruled that everything under the sun is interstate commerce, leaving itself little choice but to reverse Paul two years later in United States v. South-Eastern Underwriters Ass’n, 322 U.S. 533 (1944).

Now, for the first time in U.S. history, an industry which had been regulated exclusively by the states was suddenly open to being taken over by the U.S. Congress. Congress responded to this radical shift the following year by enacting the McCarran-Ferguson Act, 15 U.S.C. §§ 1011-1015, which generally exempts the business of insurance from the scope of any federal law that does not specifically apply to it. Given that McCarran-Ferguson restricts federal statutes generally, and not antitrust laws in particular, it strikes me as more than a bit odd that it is routinely referred to as an “antitrust exemption” rather than as the more general “federal law exemption” that it is. This anomalous designation is made even more perverse by the fact that McCarran-Ferguson does single out antitrust laws specifically, but in a manner limiting their exemption relative to other statutes rather than expanding it. Section 1012(b) provides that:

No Act of Congress shall be construed to invalidate, impair, or supersede any law enacted by any State for the purpose of regulating the business of insurance, or which imposes a fee or tax upon such business, unless such Act specifically relates to the business of insurance: Provided, That after June 30, 1948, the Act of July 2, 1890, as amended, known as the Sherman Act, and the Act of October 15, 1914, as amended, known as the Clayton Act, and the Act of September 26, 1914, known as the Federal Trade Commission Act, as amended [15 U.S.C. 41 et seq.], shall be applicable to the business of insurance to the extent that such business is not regulated by State Law.
[Emphasis added.]

Not only do insurers not enjoy a specific exemption from the Sherman and Clayton Acts; these two statutes (along with the FTC Act) actually enjoy significant exemption from the exemption that would further restrict any other federal statute. In other words, while insurers are exempt from any other federal law that does not reference insurance, they are exempt from federal antitrust laws and the FTC Act only if and to the extent that the states pick up the slack.

This combination of federal non-regulation and strict state regulation leaves precious little for insurers to do in the way of antitrust that other companies would be forbidden to do by federal law alone. Mostly, insurers are allowed to share loss experience, which makes it possible for smaller insurers to price their risks appropriately. If an insurer has enough loss experience and a good enough actuary, there are no bad risks, only inappropriately priced ones. But if the insurer lacks the data needed to price a risk appropriately, it has only three choices:

1. Guess randomly as to the cost of the risk, and hope they didn’t guess too low.
2. Guess high, and either make money hand over fist or at least not lose their shirt.
3. Refuse to insure the risk at all.

No insurer that isn’t insane would opt for #1, as guessing low could threaten their insolvency. In an otherwise free market, they might go for #2, assuming they had enough data that there was some price out there that they knew would be sufficiently high to cover any plausible losses. But given the strict regulation that exists in most states, particularly with respect to personal lines insurance, regulators are unlikely to approve a rate based on a SWAG, so the most likely result will be #3. At this point, only the largest insurers will be able or willing to insure the most specialized risks, and they will have very little competition to drive prices down any further than the highest rate they can talk a regulator into accepting. States, having regulated insurance from the early days of the republic, understand this. The federal government, having never regulated insurance at all, does not, except that they have understood it well enough to know to butt out. Until now, anyway.

None of this is to suggest that federal regulation of insurance is necessarily a bad idea. Done properly, it could provide the same consumer protections that most states do, while making it much easier for smaller and medium sized companies to do business across state lines. Nor is it to cast doubt on the constitutionality of such a proposal; if Congress can charter banks, surely it can charter insurers as well. It is to say, however, that that is the debate we need to be having as a nation – “Should the federal government regulate insurance?” – and not a debate over McCarran-Ferguson minutiae in a vacuum.

Full disclosure: I work for an insurance company that would be affected by federal regulation of insurance generally, but not by H.R. 3596.