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entitled 'Ultimate Effects of McCarran-Ferguson Federal Antitrust 
Exemption on Insurer Activity are Unclear' which was released on August 
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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)[Footnote 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 the McCarran exemption.[Footnote 2]

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.

Background:

Congress passed the McCarran-Ferguson Act (McCarran) in 1945, following 
a Supreme Court decision that determined that insurance is interstate 
commerce which Congress could regulate and subject to federal antitrust 
laws.[Footnote 3] 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 ratemaking 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 
historical data.[Footnote 4]

Some experts have suggested that absent the McCarran exemption, 
activities in the property/casualty area, especially joint ratemaking, 
might violate federal antitrust 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 ratemaking, property/casualty insurers rely on rating 
organizations.[Footnote 5] 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 ratemaking 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.

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' ratemaking 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 insurers from joint trending 
in some lines of insurance.[Footnote 6] 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 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 make 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 
available to other interested parties and others upon request. It will 
also be available on GAO's home page at [Hyperlink, 
http://www.gao.gov]. If you or your staff have questions regarding this 
report, please contact me at (202)-512-8678 or hillmanr@gao.gov. 
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,

Signed by:
Richard J. Hillman:
Director, Financial Markets and Community Investment:

Enclosure:

FOOTNOTES

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

[2] GAO, Legal Principles Defining the Scope of the Federal Antitrust 
Exemption for Insurance, B-304474 (Washington, DC: March 4, 2005).

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

[4] California's Proposition 103, codified at Cal. Ins. Code §§ 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 Cong. (1994), also carved out certain 
activities to avoid further litigation in these areas.

[5] States authorize rating organizations, sometimes called statistical 
or advisory organizations, to assist in the ratemaking 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.

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

Enclosure:

McCarran-Ferguson Antitrust Exemption:

Briefing for Committee on Financial Services House of Representatives 
May 26, 2005:

Overview:

Background:

* Federal antitrust laws whose application is affected by the McCarran- 
Ferguson (McCarran) exemption:

* Other possible sources of federal antitrust immunity 
* State 
antitrust authorities:

Insurance activities that might require McCarran exemption Insurance 
regulation and antitrust authorities in selected states:

Scope and methodology:

Scope:

* Restricted to property/casualty and workers compensation 
* State 
analysis primarily in 5 states - California, Illinois, New Jersey, New 
York, and Texas:

Methodology:

* Review of literature including congressional hearings, Department of 
Justice (DOJ) studies, and American Bar Association (ABA) documents.

* Interviews with staff at state insurance departments, attorneys 
general offices, the National Association of Insurance Commissioners 
(NAIC), trade associations, and insurance companies, and with legal 
experts and academics.

Background: Federal antitrust laws:

The Sherman Act:

* Section 1: concerted acts or practices in restraint of trade:

* Section 2: monopolization:

The Clayton Act:

* Mergers and acquisitions that may substantially lessen competition or 
tend to create a monopoly:

* Interlocking directorates:

The Federal Trade Commission (FTC) Act 
* Unfair methods of competition:

* Unfair or deceptive acts or practices:

Background: Court analysis under Section 1 of Sherman Act when 
exemptions don't apply:

Some types of restraints are considered per se unreasonable and can be 
presumed illegal without inquiry into their purpose or competitive 
harm. These include:

* Price fixing:

* Market or customer allocation:

* Group boycotts:

Other types of restraints are considered under the rule of reason, 
which requires analysis of the circumstances to see if the conduct 
promotes or suppresses competition. These include joint venture 
arrangements.

According to DOJ, while technically illegal per se, tying is usually 
considered under the rule of reason.

Background: Prerequisites for statutory McCarran exemption:

* Practices must constitute the "business of insurance."

* Practices must be "regulated by State law."

* Practices must not constitute agreements or acts of boycott, 
intimidation, or coercion.

See GAO, Legal Principles Defining the Scope of the Federal Antitrust 
Exemption for Insurance, B-304474 (Washington, DC: March 4, 2005) for 
more information on the prerequisites.

Background: Some sources of federal immunity other than McCarran:

State Action Doctrine - Shields certain anticompetitive conduct when 
that conduct is part of a clearly articulated state policy and actively 
supervised by the state.

* Clear articulation requirement is met if the state clearly intends to 
displace competition in an area with a regulatory structure. 
* Active supervision requirement is met if state regulators have and 
exercise statutory authority to review the conduct.

Noerr-Pennington Doctrine - Shields certain joint efforts by groups, 
such as trade associations and industry groups, seeking to exercise 
their First Amendment rights to petition the government.

Background: State antitrust authorities:

According to legal experts, states exempt insurance practices from 
state antitrust laws in a variety of ways:

* by exempting specific insurance activities or products,

* by broadly incorporating federal exemptions into state law, and:

* by exempting regulated industries including insurance. In recent 
years, some states have narrowed their exemptions.

States have other authorities for targeting practices that might 
violate federal antitrust laws, including:

* statutory provisions specific to the insurance industry, and:

* generally applicable unfair or deceptive practices statutes.

A cautionary note:

* Application of the federal antitrust laws through court cases is 
highly dependent on the facts and circumstances of each case.

* Because the McCarran exemption exists, the application of federal 
antitrust laws to insurance activities has not been fully tested in the 
courts.

* As a result, it is difficult to reach firm conclusions about the 
application of the federal antitrust laws to insurance activities.

Insurance activities that might require McCarran exemption:

Joint rate development 

* Risk classification:

* Product (form) standardization 
* Loss costs:

Others:

* Joint underwriting:

* Marketing and distribution:

Joint rate development: Rating/statistical organizations play a major 
role:

Establish risk classifications and develop policy forms Take actions to 
ensure that data are reliable Aggregate historical data on loss costs:

Develop loss costs for events that have occurred but have not yet been 
reported:

Trend loss costs to provide advisory prospective loss costs, including:

* analyzing past trends to project them into the future, and:

* using other information such as economic forecasts, perceptions of 
judicial temperament, and expected changes in medical costs to further 
refine their projections.

In some workers' compensation areas, such as residual markets, add 
expenses, taxes, and profits onto prospective loss costs to produce 
rates.

Joint rate development: Types of rating/statistical organizations:

Organizations specialize. 

* Property/Casualty:

* Workers' compensation:

Organizations can be national, regional, or local.

According to NAIC, there are 25 rating/statistical organizations.

The rating/statistical organizations are licensed in the states where 
they provide services.

Joint rate development: Rating/statistical Organizations - Property/
Casualty:

Insurance Services Office (ISO) is the major national rating 
organization for property/casualty insurance:

* Prior to 1994 owned and operated by insurers

* Current structure and operations:

- For profit:

* Employees managers, and directors hold class A stock and elect 10 of 
14 directors:

* Insurers hold class B stock and elect 3 of 14 directors

- Members provide data:

* For personal lines, 35 percent of the market:

* For commercial lines, 60-65 percent of the market

* Members also provide advice and use forecasts:

Other rating/statistical organizations operate nationally or regionally 
and provide varied services:

Joint rate development: Rating/statistical Organizations - Workers' 
Compensation:

National Council on Compensation Insurance (NCCI) is the only 
multistate organization:

* Not for profit:

* 14 member board, about 2/3 represent insurers 
* Provides some 
services in 38 states:

* Members provide data and advice and use forecasts 
* Provides residual 
market services and administers National Workers Compensation 
Reinsurance Pool Some states have their own organizations; however, 
NCCI provides some services in several of these states.

Possible benefits of this process identified by industry, regulators, 
and experts:

Standardized risk classifications and forms make data more credible.

One or a few organizations collecting and analyzing data reduces costs 
(economies of scale) and improves quality of analysis.

Advisory loss costs and forms make it less costly to enter new markets.

Standardized forms lower legal costs because the language has been 
tested in the courts and may facilitate risk sharing.

Advisory loss costs and standardized forms lower regulatory costs for 
filing rates and forms for both insurers and regulators.

Standardized risk classifications and forms facilitate product 
comparisons for consumers.

Possible Issues: Standardized risk classifications and forms:

While standardization exists in other industries, legal experts have 
said that product standardization in insurance may have a greater 
impact on price than it has in other industries and may thus be subject 
to antitrust litigation.

Standardized risk classifications and policy forms may limit

* Consumer choice,

* Competition, and:

* Innovation. 

Standardized risk classifications and policy forms have social 
implications.

Possible Issues: Loss costs:

Collection of historical loss costs and loss development:

* Legal experts have said that these activities may not violate federal 
antitrust laws in the absence of McCarran.

- Do not in themselves constitute price fixing:

- May make the market more competitive and efficient:

* However, court outcomes are uncertain:

Joint trending to develop advisory, prospective loss costs:

* Legal experts have said that these activities may violate federal 
antitrust laws in the absence of McCarran.

- Collective activity establishes a significant portion of final 
insurance price.

- Although advisory, sends strong pricing signal to market participants.

- Relativities constitute element of price fixing.

* While many legal experts believe potential for collusive behavior 
outweighs potential for increased efficiency, some experts believe the 
activity is procompetitive.

A dominant trending organization may lead to inaccurate pricing and 
limit innovation.

Other Possible Issues:

McCarran exemption is broad relative to almost all other antitrust 
exemptions, which raises questions about the uniqueness of property/
casualty insurance:

* Industry experts say unique because of:

- Uncertainty about costs at time product is sold:

- Longtime horizon:

- Insolvency has social costs:

* Some experts do not think that it is so unique as to require federal 
antitrust exemptions that most other industries do not have.

Court determinations in non-insurance antitrust cases often depend on 
whether market participants have power to exert control over the market.

* Because of exemption, insurance has not been subjected to competitive 
or unfair practices analysis by federal antitrust agencies:

* NAIC, some states, and academic experts have done limited competitive 
analyses:

Some sources of federal immunity other than McCarran:

Joint rate and form activities might still be immune from federal 
antitrust laws under state action doctrine:

* Statutes or regulations would need to specify or imply that these 
regulations are replacing a competitive (market) regime. If firms 
independently set final rates, questions might be raised concerning 
this requirement.

* States would need to supervise and enforce rate and form regulations.

* The state action doctrine was argued i n in re Insurance Antitrust 
Litigation.

To the extent that insurers' applications to states for specific rate 
and form regulation can be seen as petitioning the state, the Noerr- 
Pennington doctrine might apply.

Other activities that might require McCarran exemption:

Joint Underwriting:

* To extent that activities are efficiency-producing and not related to 
price fixing, they are not likely to violate federal antitrust laws in 
the absence of McCarran.

* DOJ/FTC have guidelines to evaluate extent to which joint ventures 
would violate antitrust laws.

- Recognizes that collaboration can be procompetitive:

- Only agreements "of a type that always or almost always tends to 
raise price or reduce output" are per se illegal.

Marketing and Distribution:

* To extent that insurer-agent activities constitute tying they might 
violate federal antitrust laws in absence of McCarran:

Types of joint underwriting activities:

Residual markets:

* Assigned risk plans:

* Joint Underwriting Associations:

Pools:

* Aviation

* Nuclear:

Ad hoc arrangements:

Information joint ventures to prevent fraud

* Medical information bureaus:

* Fire losses:

Types of marketing and distribution activities:

Agreements among agents or among insurers such as those related to 
commissions:

Agreements among insurers and independent agents:

* Exclusive agent relationships, where an agent agrees to represent 
only one insurer:

* Agreements restricting agents to certain products, territories, or 
customers:

* Agreements related to agent terminations Bundling of products 
(coverages):

Regulation in five states: rate regulation:

State: California;
Property/Casualty: Prior Approval;
Workers' Compensation: File and Use: state rating organization.

State: Illinois;
Property/Casualty: Commercial: no filing required; Personal: use and 
file;
Workers' Compensation: File and use.

State: New Jersey;
Property/Casualty: Commercial: Use & file unless find that competition 
does not exist. Personal: prior approval;
Workers' Compensation: Prior approval: state rating.

State: New York;
Property/Casualty: Personal auto: prior approval; Commercial Liability: 
flex between bands; Other: file and use;
Workers' Compensation: Prior approval: state rating.

State: Texas;
Property/Casualty: File & use; File & use;
Workers' Compensation: File and use.

Source: NAIC and state regulators in the 5 states:

[End of table]

Regulation in five states: antitrust:

State: California;
State antitrust law: Cartwright Act;
Insurance exemption: Exemption only for collection of historical data, 
joint trending by rating organizations, and joint arrangements to 
ensure availability of insurance.

State: Illinois;
State antitrust law: Illinois Antitrust Act;
Insurance exemption: Exempts activities that are subject to regulation 
by the Director of Insurance or permitted or authorized by state law.

State: New Jersey;
State antitrust law: New Jersey Antitrust Act;
Insurance exemption: Exempts activities subject to supervision by 
commissioner or authorized by state law.

State: New York;
State antitrust law: Donnelly Act;
Insurance exemption: Exempts activities covered by New York's insurance 
code regulating property/casualty rates.

State: Texas;
State antitrust law: Free Enterprise and;
Insurance exemption: No general immunity; immunity for activities 
required by state or federal law.

Source: GAO:

[End of table]

Regulation in five states: Other related state authorities:

State: California;
Other related authorities: Unfair Practices Act, Unfair Competition 
Law, Unfair Insurance Practices Act.

State: Illinois;
Other related authorities: Consumer Fraud and Deceptive Business 
Practices Act. Insurance code provisions for unfair methods of 
competition and unfair or deceptive acts and practices.

State: New Jersey;
Other related authorities: Insurance code provisions for unfair methods 
of competition or unfair or deceptive acts or practices.

State: New York;
Other related authorities: Executive law, general business law, and 
insurance law provisions proscribing repeated fraudulent or illegal 
acts, restraints of trade and unfair competition, and deceptive acts or 
practices.

State: Texas;
Other related authorities: Deceptive Trade Practices-Consumer 
Protection Act. Insurance code provisions for unfair methods of 
competition and unfair or deceptive acts or practices.

Source: ABA, State Antitrust Practice and Statutes, 3rd edition, and 
state officials in the 5 states:

[End of table]

Summary and conclusions:

As noted, it is difficult to reach firm conclusions about the 
application of federal antitrust laws to insurance activities because 
often the courts have not considered these issues.

Over the years, most experts have said that collection of historical 
data would likely not violate federal antitrust laws absent McCarran; 
however, they are less certain that courts would find joint trending to 
be consistent with federal antitrust law absent McCarran.

Because of the uncertainty about what the courts will do, "safe 
harbors" for certain activities such as the collection of historical 
data have often been used when eliminating or proposing to eliminate 
immunities for insurance at the state and federal levels.

Generally, larger carriers expressed less concern about maintaining the 
McCarran exemption than smaller carriers.

Other Ongoing Studies:

* The ABA is planning to issue an update of The Insurance Antitrust 
Handbook later this year.

* The Antitrust Modernization Commission is considering specific 
immunities and exemptions as well as the state action and Noerr- 
Pennington doctrines.

[End of Section]