Who You Gonna Call? John Edwards, Malpractice Insurance Trust Buster!

It looks as though I may have missed the biggest bit of news hidden away in the Kerry-Edwards campaign's proposals for medical malpractice reform, discussed below.

In his link to the previous post, Walter Olson (Overlawyered) points out the campaign's unusual "failure to raise federalism objections which ordinarily are front and center in Democratic resistance to liability reform at a national level." He is right to raise that question, because it appears that one of the principal goals of the Kerry-Edwards proposal is to chip away at the statute that has served as the cornerstone of American insurance regulation for the past 60 years.

If you re-read the quote from the Kerry-Edwards campaign site in the preceding post, you may note one provision on which I did not comment. For purposes of lowering medical malpractice insurance premiums, the Two Senators Named John propose to:

Eliminate the special privileges that allow insurance companies to fix prices and collude in ways that increase medical malpractice premiums.

"'Special privileges?' What's that about?" you may wonder, as well you should. The answer is to be found, with a little help from Google, in a May 20, 2003 Washington Post editorial, still available on Senator Edwards' own campaign site. The first reform proposal Senator Edwards offered in that editorial -- before reducing the number of "frivolous" suits or reducing "preventable medical errors" -- is this:

The most critical step is reforming the insurance industry. Today insurance companies use slow and burdensome processes to discourage both doctors and patients from filing legitimate claims. Worse still, these companies can fix prices and divvy up the country in order to drive up their profits. Even when companies don't explicitly collude, they set their rates based on a trade-group loss calculation that they know other companies will follow. In any other industry, this kind of conduct would be subject to scrutiny under the antitrust laws. But an obscure 1945 law gives insurance companies a broad antitrust exemption. Because of the insurance lobby's influence, Congress has even blocked the Federal Trade Commission from investigating insurance company rip-offs. These special privileges must go.

(Emphasis added.)

The "obscure 1945 law" to which the Senator refers is the McCarran-Ferguson Act, 15 U.S. Code, sections 1011-1015, (viewable here), which embodies the very conscious decision of the Congress -- a then-Democratic Congress -- to leave most regulation of the insurance industry to the states, rather than to the federal government. Here is a compact summary from the American Medical Association:

The McCarran Act is the federal law authorizing state regulation of insurance. The act also provides a limited federal antitrust exemption for the business of insurance, subject to state regulation and oversight, for activities such as joint data collection that help foster a competitive marketplace benefiting consumers. Furthermore, the exemption does not insulate insurers from the enforcement of state or federal antitrust laws in the context of anti-competitive business practices such as boycott, coercion or other intimidation in the marketplace.

The roll-back of McCarran-Ferguson -- and therefore the expansion of federal regulation of the insurance industry and the reduction or elimination of well-established state authority -- has been on the agenda of the plaintiffs' bar for many years. As recently as 2003, at about the time he wrote that editorial, Senator Edwards was a co-sponsor (with Senators Leahy, Kennedy, Feingold and Boxer among others) of the Medical Malpractice Insurance Antitrust Act of 2003, Senate Bill 352, the substance of which is contained in this paragraph:

Notwithstanding any other provision of law, nothing in the Act of March 9, 1945 (15 U.S.C. 1011 et seq., commonly known as the `McCarran-Ferguson Act') shall be construed to permit commercial insurers to engage in any form of price fixing, bid rigging, or market allocations in connection with the conduct of the business of providing medical malpractice insurance.

The sole purpose of the bill is to repeal McCarran-Ferguson -- but only as to medical professional liability insurance, and only in connectio with activities (the nasty-sounding "price fixing, bid rigging, or market allocations") as to which it is virtually certain that the states already have full authority to act. Not only do the individual states have the requisite authority to address claimed anti-competitive activity directly, each state also has the power and incentive to launch a direct assault on any insurance rate that is genuinely "too high." Every state already prohibits insurers from charging rates that are excessive or discriminatory, and in many states -- California among them -- premium rates must be pre-approved by the Department of Insurance before they can be used at all.

Presumably, the elimination of McCarran-Ferguson from medical malpractice insurance is intended as a prelude to repealing it altogether, "federalizing" insurance regulation as a whole. Regardless of the merits of that idea, it is troubling that the Kerry-Edwards campaign has seen fit to bury such a fundamental change in vague language appended as little more than a footnote to its other malpractice-related proposals.

Caveat emptor.

(Postscript: Thanks as well to Medpundit for linking the previous entry on this topic.)

For Further Reading:

The Congressional Research Service of the Library of Congress prepared a succinct and evenhanded analysis of Senator Leahy's bill, which identifies the arguments on both sides.

Those who want a more detailed economic analysis of how McCarran-Ferguson affects pricing and competition in insurance might review an article written by Professor Patricia M. Danzon of the Wharton School of the University of Pennsylvania, for the Cato Institute in the early 1990's, entitled "The McCarran-Ferguson Act Anticompetitive or Procompetitive?" Here is Prof. Danzon's summary of the reasons favoring collective action and information sharing among liability insurers, i.e., the benefits of the sort of activities that would be prohibited under the Kerry-Edwards proposal:

In fact, it is highly likely that repeal would actually reduce competition, increase the cost of insurance, and reduce the availability for some high-risk coverages, because the threat of antitrust litigation would make insurers unwilling to engage in efficiency-enhancing cooperative activities.

Insurers are in the business of assuming risk. Collective activities that increase information or spread risk among insurers tend to reduce the price of insurance. Collective action is most important for loss forecasting and pricing accuracy. The fair or competitive price of an insurance policy is equal to the present value of expected losses (including claim adjustment or litigation expense), discounted to reflect expected investment income and adjusted for taxes and a normal return on capital. Forecasting expected losses on a pool of policies is relatively simple for stable lines of insurance such as life insurance, where losses across policyholders are uncorrelated and trends over time are stable. For any pool of risks, the predictive accuracy achieved with a given number of policies is lower, the larger the variance of the underlying loss distribution, the higher the correlation between losses for individual policyholders in the pool, and the less certain the estimates of the parameters of the underlying loss distribution.

All of the factors that tend to undermine predictive accuracy for insurers apply more to liability insurance lines than to life insurance and are most severe for general liability, because general liability losses are highly dependent on the trends in tort law. The fact that both the frequency of claims and the size of awards against policyholders are influenced by trends in tort law induces a positive correlation of outcomes for individual risks in the pool. Differences in judicial rulings across jurisdictions and changes over time mean that the parameters of the underlying loss distribution cannot be estimated with precision.

Unpredictability is greater, the longer the duration of the liability. The so-called long tail of liability is more extreme for general liability than for other lines because in most states the statute of limitations for product liability does not begin to run until the discovery of the injury giving rise to the complaint, which may be many years after the insurance policy was written. The average lag between pricing the policy and paying out on claims is around five years for general liability and may be as long as twenty years or more for coverage of long-lived capital equipment and products that may be linked to cancers with very long gestation periods.

In addition to the uncertainty created by a long exposure period during which rules of tort law may undergo dramatic change, general liability is characterized by a huge range in possible losses for any policyholder. Although most policyholders will have no claims in a particular policy year, there is a small chance of a multimillion dollar loss in the event of a severe personal injury with a large pain and suffering award, multiplied manyfold if there are multiple claims from the same product line. Interstate differences in tort regimes and the potential for forum-shopping by plaintiffs exacerbate the uncertainty.

Those characteristics of the underlying loss distribution--high variance, high correlation, and imprecise parameter estimates because of dependence on tort regimes that differ across states and over time--mean that the experience of any single insurer typically gives a very imprecise estimate of expected losses for a given class of insureds in a single state. Precision in loss forecasts can be increased by pooling the loss data of multiple insurers, provided that the losses reflect similar policy provisions. Because the losses for a particular policy year are paid out over many years, the accuracy of loss forecasts requires tracking and analyzing payout patterns (loss development) and trends over time in the underlying loss distribution. Thus, as long as the underlying tort system remains unpredictable, loss forecasts for liability insurance will remain imprecise and there will be gains from using common policy forms and pooling loss experience, including estimation of loss development and trends over a period of years.

Comments

[david giacalone]

George, you've awaken some long-repressed memories for me by discussing the McCarran-Ferguson Act. My main assignment when I first joined the FTC in 1978 was to become an expert on the M-FA exemption to the antitrust laws. I ended up writing the proposal for amending the McCarran-Ferguson Act that was adopted by the President's National Commission for the Review of the Antitrust Laws and Procedures (1979).

It's rare that I see you catastrophizing, but you seem to be doing so here. Let me make a few quick points:

1) Enforcing the antitrust laws is not "regulation" as that term is traditionally used -- no more than enforcing laws against theft and murder.

2) M-FA is far more a symbol of the power of the insurance industry than a valiant tribute to states' rights. The fact that the Supreme Court had held prior to U.S. v. South-Eastern Underwriters Assn, 322 U.S. 533 (1944), that insurance was not "commerce" under the Commerce Clause, made no more sense than the continuned holding today that baseball is not commerce.

3) The fact that insurance is regulated by states is scarcely a good reason to exempt it from the federal antitrust laws. Telephone, gas, electricity, and the learned professions are examples of state-regulated businesses that have no special antitrust exemption. The insurance industry exemption is indeed quite "special."

4) As the Supreme Court said in Group Life & Health Ins. Co. v. Royal Drug Co., 440 U.S. 205, 221, 224 (1979), M-FA was passed in reaction to the SEUA decision, with the "primary concern of both representatives of the insurance industry and the Congress was that cooperative ratemaking efforts be exempt from the antitrust laws" as long as they were regulated by the state.

5) Since at least 1978, both federal antitrust enforcement agencies have consistently stated -- as they did separately to NCRALP -- that the joint pooling of data done by insurance companies to assess and underwrite risks would be entirely legal under the federal antitrust laws, because the conduct does in fact create needed efficiencies and enhance competition. To make that point perfectly clear and allay fears, the FTC and DOJ each recommended that the repeal of the M-FA antitrust exemption include explicit immunity for such conduct, even though none was required to allow the practices to continue.

6) Despite having a broad array of congressional leaders as Commission members [see fn. 50], such as liberal politicians Edward M. Kennedy, Jacob K. Javits, Howard Metzenbaum, Peter Rodino and Barbara Jordan, along with conservatives like Orrin Hatch, the final recommendations of NCRALP called for the repeal of the antitrust portion of the McCarran-Ferguson Act, but included the specific protection for joint data pooling and risk assessment.

7) Pooling risk assessment data to allow rate-making is a lot different than price fixing -- which is competitors jointly setting rates. Price fixing should be unlawful, even if state regulators review submitted premium levels.

8) The loss of the federal antitrust exemption should not in any way affect the legitimate operation and regulation of the business of insurance. Many state regulators and attorneys general have long supported repealing the exemption.

9) The issue has come up in the context of health care insurance and malpractice insurance, because doctors and other providers (who cannot jointly negotiate fees) have argued that the existence of the M-FA exemption gives insurers and HMOs unfair bargaining advantages.

Okay, now I shall repress this information again and get back to the business of (under)writing haiku.

[david giacalone]

After trading emails with Walter Olson and Martin Grace, I want to point out that Sen. Edwards' statements are in fact rather benign. He says that he is against "price fixing," "divvying" up markets, and forms of colluding that raise premiums (targets that are hard to fault). He then points out that, even when not colluding directly, insurers might knowingly set premiums in a coordinated way that keeps premiums high -- and that such conduct would at least receive "antitrust scrutiny" in every other industry.

As many an antitrust plaintiff or prosecutor can tell you, "scrutiny," is a lot different than "condemnation" or "prohibition." The distinction is crucial here, since antitrust scrutiny of interdependent action has become less and less strict (if not totally passe), and top enforcers have been going out of their way to say that information sharing can be procompetitive.

As with most things political or ideological, anti-Edwards folks seem to be cherry-picking his statements for phrases to use to attack him, and then distorting the meaning of even those few phrases. Of course, more even-handed coverage is expected here at Decs & Exs than from more baldly partisan or crusading websites.

Prof. Grace made it clear today that he agrees with me: antitrust would not outlaw the kinds of information sharing done by insurers to assess risk. For additional reference, please see State of FTC Chairman Daniel Oliver to the U.S. Senate (1987, supporting repeal of the M-FA antitrust exemption):

"The tragic irony -- for consumers -- is that McCarran-Ferguson is simply not necessary. States may regulate insurers with or without McCarran-Ferguson. And the forms of insurer cooperation needed for efficiency are perfectly legal under the antitrust laws."

The DOJ/FTC Policy Statement on Health Care Antitrust Enforcement (1996) also makes it clear that many forms of information exchange between competitors that are far less crucial than insurer risk assessment would pass antitrust muster.

Finally, see the Opinion Letter of FTC Staff to Washington State Legislature (2002), where the FTC lawyers explain:

"The antitrust laws do not prohibit information exchanges that are unlikely to harm consumers. The Supreme Court has determined that information exchanges among competitors must be evaluated on a case-by-case basis to determine whether their benefits outweigh any potential anticompetitive effects. [See United States v. United States Gypsum Co., 438 U.S. 422 (1978).] In an assessment of the net effect of a particular exchange, the decisive issue is the impact on consumer welfare. Thus, if a plaintiff cannot show that an information exchange among competing providers is likely to injure consumers, the practice would not be held unlawful."

[david giacalone]

p.s. The bill proposed by Sen. Edwards and others relating to medical malpractice insurance and M-FA is narrowly focused:

"Notwithstanding any other provision of law, nothing in the Act of March 9, 1945 (15 U.S.C. 1011 et seq., commonly known as the `McCarran-Ferguson Act') shall be construed to permit commercial insurers to engage in any form of price fixing, bid rigging, or market allocations in connection with the conduct of the business of providing medical malpractice insurance. "