Insurance And Antitrust

I had my annual physical two weeks ago, providing my left-wing doctor the opportunity to berate conservative politics immediately after making me assume a posture from which dispute would be ill-advised. Later in the exam, the discussion heated up (Dr.: "A government program like Medicare is the answer"; NOfP: "Isn't it true you don't accept Medicare?"). And it ended when my doc insisted that the main flaw in healthcare is that insurance companies are exempt from the antitrust laws. He asserted that the exemption gave insurers excessive market power over doctors and other care providers, thus increasing healthcare prices.

Senate Majority Leader Harry Reid agrees, as do many progressives and the mainstream media. Indeed, a pending bill (HR 1583) would repeal the exemption. Are they right?

Background: 15 U.S.C. § 1012 exempts "the business of insurance" from, among other things, antitrust law except "to the extent that such business is not regulated by State Law." This provision is part of the 1945 McCarran-Ferguson Act, passed in response to a 1944 Supreme Court decision classing insurance as "interstate commerce" subject to Federal law, including antitrust law. Previous court decisions were to the contrary, for reasons beyond the scope of this post.

Purpose: The exemption wasn't merely a corporate give-away. Insurance is grounded on risk pooling---aggregating sufficient individual risks to a more predictable average (via the law of large numbers), and therefore spread risks. But the efficient accessing, pricing and marketing of risks requires sharing information about a basis to assess the probability of liability, as noted in a 2005 General Accounting Office report (at 3) about another type of insurance:

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.

In addition, insurers further spread risk through reinsurance, where, in return for a premium, one company indemnifies a portion of the risks of another. As a 2007 Congressional Research Service report concluded (at 5), "the specific economics of the insurance industry [suggest that] cooperation among insurers may very well result in greater efficiencies."

The net result, in theory, is to make insurance more affordable to consumers. As a rough analogy, consider the antitrust exemption for labor unions. Obviously, without such an exemption, collective bargaining would be unlawful--but joint employee negotiations with management is the core public interest rationale behind unionization. In each case, economics suggests that a limited antitrust waiver achieves pro-competitive results.

Scope: In practice, the breadth of the McCarran-Ferguson carve-out is severely limited by two factors. First, the "business of insurance" exempted from antitrust has been narrowly construed by courts to activities central to the purposes described above. The Supreme Court summarized the criteria for antitrust exemption in a 1982 case:

first, whether the practice has the effect of transferring or spreading a policyholder's risk; second, whether the practice is an integral part of the policy relationship between the insurer and the insured; and third, whether the practice is limited to entities within the insurance industry.

As a result, the clause does not, for example, sanction all mergers between insurance companies. Indeed, the Department of Justice has blocked several proposed mergers, and required pro-competitive divestiture in others--and has always had the authority to preserve an open marketplace. Relatedly, Section 1013 of the act preserves the applicability of Federal antitrust law to "any [insurance] agreement to boycott, coerce, or intimidate, or act of boycott, coercion, or intimidation."

Second, the exemption applies only to activities outside of state oversight and control. The effect of McCarran-Ferguson was to preserve the states' lead role in the regulation of insurance:

Each state has a department within the executive branch to regulate insurance. The head of the department is usually called the commissioner or director of insurance. A handful of states elect their insurance commissioner. In the remaining states, the insurance commissioner is appointed by the governor and serves at the governor’s pleasure. The insurance department typically has broad, legislatively delegated powers to enforce state insurance laws, promulgate rules and regulations, and conduct hearings to resolve disputed matters.

The specifics, and degree, of oversight varies among states, but overall:

The goals of insurance regulation articulated by most states include fair pricing of insurance, protecting insurance company solvency, preventing unfair practices by insurance companies, and ensuring availability of insurance coverage. For example, all states have the power to approve insurance rates, to periodically conduct financial examinations of insurers, to license companies, agents, and brokers, and to monitor and regulate claims handling.

Indeed, states often cooperate in joint actions against insurance companies. While states have been slow to regulate some aspects of insurance -- derivatives, swaps and similar financial products that some blame for the financial melt-down -- these are not at issue in heath insurance.

Net effect: Considering the pro-competitive intent of Section 1012 of the McCarran-Ferguson Act, its narrow reach in practice, and the existence of comprehensive state regulation of state health insurance, the exemption of "the business of insurance" from Federal antitrust laws, that provision does not give health insurers unfair advantages over patients, doctors, drug companies or hospitals. So the law isn't likely the cause of the asserted flaws in American healthcare.

Competition: Importantly, I'm not asserting that there's sufficient competition in the heath insurance industry. Indeed, I've consistently favored legislation that eliminate insurers' current disincentive to compete to serve individual consumers. And to allow interstate competition between insurers. But both such flaws are the products of over-regulation: tax-laws tying health insurance to employment, so limiting much competition to the employer, not employee, level, plus absurd mandates and guaranteed issue/community rating imposed by state insurance regulators.

There are legitimate disagreements over whether a single national insurance regulator is preferable to multiple state bodies. But if the inevitable consequence of state-by-state regulation is a lack of interstate competition among insurers, then unified Federal regulation of insurance might be preferable. Yet, according to Obama adviser Tom Daschle on the September 6th This Week (ABC), selling insurance across state lines would be a "race to the bottom" as states compete for the lowest cost insurance offerings. I thought that was the goal--which illustrates the extent to which the Administration is utterly out-of-touch.

Conclusion: Interstate insurance competition would require revising McCarran-Ferguson to remove the deference to state oversight. But not to repeal the antitrust exemption. Contrary to my doctor -- and Senators, lefty bloggers and the mainstream media -- that's not the problem.

UPDATE: The Wall Street Journal agrees.