laws which have been criticized for not being competitive because of conditions over which antitrust enforcement techniques are either unable or unwilling to correct. (The comments above on antitrust enforcement are relevant here.) Where antitrust is unsuccessful in effectuating vigorous competition, and no other agency has jurisdiction, a regulatory vacuum is created rendering the public vulnerable to abuse. Nevertheless, application of the federal antitrust laws under S. 1710 could produce precisely this result.

The bill would eliminate authority of the states to oversee insurance rates. For those groups of people and for those lines of coverage where competition is not effective, the public would have no protection to potentially exploitive rates. The only potential restraint is the imposition of rate controls. The proposed bill now rejects this potential restraint.

In contrast, the state open competition rating laws are much more flexible. As long as workable competition exists, primary reliance is placed on competition to regulate rates. However, if after applying tests of workable competition, the insurance regulator determines that competition is not effective, he may reinstitute a rate approval mechanism until competition becomes viable again. A regulatory vacuum is avoided and the public is protected. Similarly, the same result can obtain under most nonopen competition states when the regulator applies the statutory rate standards in terms of competition and exercises his disapproval power only where competition is not effective. Consequently, in the context of the insurance industry, the state insurance regulatory mechanism affords a better opportunity to protect the public. States use a blend of competition and other regulatory techniques rather than blind adherence to the federal antitrust laws as proposed by S. 1710.

4. S. 1710 would likely result in Federal rate regulatory control

Despite the intended purpose to foster competition through application of the antitrust laws, it is likely that federal rate regulation would be the ultimate result of S. 1710. Most industries that are subject to comprehensive federal regulation do not compete on the basis of price. Transportation, banks, energy and utilities are prime examples. Granted, there is talk of deregulation, e.g., airlines, but it would undoubtedly take years to build competition to the level now existing in the insurance industry even if such deregulation measures are implemented.

S. 1710, which in effect amends the McCarran Act, is not likely to be enacted in its present form. There has long been an articulate influence on government pressing for increased economic control-including prices and wages-for a board range of goods and services. Creation of direct federal rate controls is a distinct possibility as a result of favorable consideration of S. 1710. Even if S. 1710 were enacted as introduced, eventual federal rate regulation should be anticipated as a possible future supplemental activity.

A very likely scenario to follow enactment of S. 1710 revolves around increasing insurance rates. Most knowledgeable observers of the property and liability insurance business believe that the application of the federal antitrust laws will do little to reduce rates. (Very rarely, if ever, is the situation such that an insurance regulator will not permit an insurer to reduce rates if it so chooses.) On the other hand, removal of state authority to regulate rates would lead to even greater rate increases than are now occurring because of the insurer's efforts to recover from the recent poor underwriting experience and the concern over the unpredictable inflationary trends. Congressional reaction to sharply rising insurance prices is predictable. Imposition of federal rate controls can be expected to follow substantial insurance rate increases.

Expectation of rate increases is not just simply speculation. For example, on February 1, 1976 the New York prior approval law for no-fault automobile insurance rate expired while the legislature debated what the appropriate time period for an extension would be. Upon expiration, the open competition rating law applied. Immediately several insurers raised their auto rates in New York by averages of 18 percent to 29 percent respectively. Unlike the situation which would prevail if only the antitrust laws applied, under the open competition law the insurance commissioner has the authority to review rate increases after the fact to determine whether they meet the standard of reasonableness. But the important point of this example is the suggestion that those insurers who now support preemption of state regulatory authority in favor of the federal antitrust laws may be doing so not with the view of increasing competition and

lowering rates but rather with visions of free pricing and the opportunity to substantially increase rates.

The prime movers for the adoption of open competition laws in the states (and for the application of federal antitrust laws to the property and liability business as a substitute for state regulation of rates) are certain insurers who want more freedom to increase prices. This has created a dilemma for state legislatures; they understand (and so do we) the rationale of the arguments for open competition marshalled in various papers. But they are also concerned about public dissatisfaction with the cost of insurance in lines like auto, homeowners, medical malpractice, etc. So a majority of the states, with legislators elected by the same people who elect members of Congress, have opted to continue with insurance laws embodying some form of a rate regulatory mechanism.

Few, if any, members of Congress would want to be held responsible for enacting legislation which significantly increases insurance rates. Consequently, the series of inevitable and substantial rate increases following enactment of S. 1710 above and beyond the current pattern, coupled with a Congressional prohibition of state controls, could very well lead to consumer pressures for reimposition of rate regulatory controls to fill the federally created void embodied in the current S. 1710 proposal. Federal rate controls would be far more rigid and inflexible than existing state rate authority.

If reliance on competition is the primary answer to rate control, the states have it in their power to provide it-and in a way that fits neatly into other aspects of state regulation. We do not need Washington to do this job. Furthermore, if open competition does not work, the state open competition laws provide machinery to give prompt relief without changing the whole system and without requiring applications to the courts for injunctive relief on a case by case basis. 5. Antitrust summary

In summary, the S. 1710 recommendations concerning the application of the federal antitrust laws to the insurance industry, if adopted, would work contrary to the interest of the insurance consuming public in at least four general ways. First, the bill would remove from the states the ability to foster competition and ignore the fact that the states are in a better position to perform this function than is the Department of Justice due to the legal standards under which they function, the nature of their enforcement mechanisms, the more specialized scope of their enforcement responsibilities and the current enforcement limitations of the Department of Justice. Second, the application of the antitrust laws to the various needed and legitimate joint activities, in effect, promises to dry up (a) sources of statistical information, particularly for smaller insurers and (b) dry up substantial segments of the U.S. domestic insurance markets, causing substantial availability problems for many business and other insurance purchasers. Third, the proposal would create regulatory vacuum in those areas in which competition does not exist and which the antitrust laws cannot compel. Fourth, favorable consideration of S. 1710 could very likely lead to a massive federal rate regulatory program.

B. ADVERSE IMPACT ON THE CONTINUING STATE INSOLVENCY GUARANTY FUND SYSTEM: A DUAL GUARANTY FUND SYSTEM IS UNWORKABLE

Drafting of this bill proceeded from a consideration of "what steps might be taken to insure protection for policyholders and to improve the quality of regulation for solvency." .” 33 The bill, however, does not suggest a means to better regulate for solvency other than giving a new bureaucracy the power to regulate for solvency as it sees fit.

To the extent that state guaranty funds are working, and they are, the alternative federal guaranty system could have only the effect of weakening and splintering into two camps the all industry guaranty mechanism. If there is truly concern with the ability of the state guaranty funds to handle major insolvencies, it makes absolutely no sense to diminish the base over which insolvency losses are spread, and thereby reduce its ability to sustain loss. The basic concept of insurance involves the spreading of risk through the law of large numbers of pooled, similar risks. The basis concept of S. 1710 is at odds with this fundamental principle.

If S. 1710 were enacted, it is possible that the shift to federal guaranty status would be made by large, more financially sound, multistate insurers seeing the

33 123 Congressional Record S. 10038.

opportunity to avoid guaranty fund assessments that would be used for the benefit of weaker competitors' policyholders. State guaranty funds, meanwhile, would find themsleves without the financial backing of insurers controlling much of the industry's assets. Such a result would be bad for the states, bad for policyholders and bad for competition. Fragmentation of the guaranty system would be a highly destructive rather than a constructive effort at reform.

According to Section 103 (i) of S. 1710, the federal commission may revoke a guaranty certificate of any participating state or federal insurer upon (a) the request of the insurer or (b) on the commission's initiative if the insurer does not comply with the federal requirements. Since state guaranty fund laws cover all insurers operating in the state, other than those which would be exempted by S. 1710, this bill presents the possibility of dumping terminally ill insurers from the federal guaranty system into the laps of the state funds. In short, S. 1710 would establish a system in which the federal government could skim off the cream of financially stable companies, thereby weakening the state guaranty fund system and possibly dump financially troubled companies back into the weakened state system to the detriment of the policyholders.

Again, it should be recalled that there is no parallel here in the banking industry. Loss of FDIC membership is akin to a kiss of death to members. We have heard no interest expressed by this committee or the Congress in seeing that the states enact competitive deposit insurance mechanisms for banks as a means to improve federal and state regulation. Precisely that, however, is being proposed for the insurance industry.

C. ILLUSORY PROMISE OF LIMITED REGULATORY INVOLVEMENT

Subsequently, we shall review some of the advantages of state regulation over federal regulation of insurance. The strength of these arguments is apparently widely recognized since much of the sales promotion efforts surrounding S. 1710 characterizes the proposal as a dual regulatory scheme in which cooperative federal and state systems complement each other. Similarly, other federal insurance proposals are said to pose de minimus federal regulatory involvement. The bill before you is characterized by proponents as one to improve solvency regulation but one "that does not provide for federal regulation of insurance sales or marketing" nor does it "eliminate the authority of state insurance regulators to prescribe policy content." " This assertion of limited federal regulatory authority is illusory if not blatantly false. The proposition is explicitly betrayed by obvious and specific language in the bill.

For example, Sec. 201 dealing with federal chartering preempts state licensure authority over federally chartered insurers without saying so in so many words. Licensure is the ultimate regulatory control avaliable to the states. A state license confers the privilege of doing an insurance business in the state. The effectiveness of subsidiary state controls necessarily depend upon the ultimate authority to terminate a nonqualifying insurer's privilege to continue its instate insurance operations. S. 1710, however, provides that a federal insurer is "deemed to be authorized to do business in any state" (Sec. 201(b) (2) (B). Notwithstanding this deeming of authority, states are supposedly permitted to "revoke the authority" of a federal insurer. However, such revocation must be accompanied by a showing of cause satisfactory to the federal commission. In other words, licensure authority would, as a practical matter, be removed from the state. Without such authority, the states do not have proper control over marketing practices, policy forms, content or other matters purportedly left to the states by S. 1710.

Interesting in itself, the only provision in S. 1710 dealing specifically with regulatory authority (Sec. 107) does not appear in Title II on federal chartering, but rather is applied to all federally guaranteed insurers-both state and federally chartered. Apparently both state and federally chartered insurers would be subject to similar federal regulatory authority. The broad grant of authority to the commission in section 107 is "to prescribe such rules and regulations as may be necessary to carry out its responsibilities. . . this Act."

S. 1710 deletes from a similar provision appearing in its 94th Congress predecessor (S. 3884) a subsidiary requirement that the federal regulator publish

34 Remarks of Jeremiah S. Buckley, Minority Staff Director, Senate Committee on Banking, Before the Insurance. Negligence and Compensation Law Section of the American Bar Association, June 4, 1977.

rules "designed to assure the fair, complete, and timely performance of its obligations to its policyholders." Since S. 1710 provides for federal guarantees of all "insurance obligations," part of the commission's responsibilities will undoubtedly be seeing that guaranteed insurers carry out their obligations (as defined and determined by the commission)—whether the bill explicitly says so (S. 3884) or not (S. 1710). This obviously encompasses market conduct and policy matters alleged to be left to state control.

A similar point was underscored several years ago by an Advisory Committee to the U.S. Department of Transportation when that agency analyzed a bill introduced by Senator Magnuson 3 to establish another federal guaranty system for insurers:

36

Inevitably, the federal agency, to protect the integrity of the fund it must administer, will find it has to reach farther and farther in the exercise of the powers conferred upon it or to seek even more powers. Financial supervision is the primary purpose and function of insurance regulation. The needs of financial regulation pervade the legal controls imposed upon insurers. Ultimately, it is inconceivable that the federal agency charged with the faithful administration of a fund derived from people in every state will be able to tolerate significant discrepancies among states in capital and surplus requirements, in investment laws, in rate regulation, and in examinations of insurers. Comprehensive Federal control will, indeed must, follow Federal financial responsibility. (emphasis added)

37

DOT agreed with these conclusions of its advisory committee, and the Administration thereafter introduced its own version of guaranty fund legislation eliminating federal regulation."

The broad grant of regulatory authority that would be explicitly granted or at least emanate by necessity from S. 1710 is incontrovertible. We find it curious that this bill is not openly acknowledged as a measure designed to supplant state regulation.

Not only does the bill create broad regulatory authority over both state and federally chartered insurers who partake of the federal guaranty, but also it plants the seed for federal regulation of the entire industry. This fact is illustrated by Section 107(b), which requires the establishment of an early warning system and clearly indicates that S. 1710 contemplates extensive regulatory involvement with the entire insurance industry.

According to the early warning system provision, the commission "may include both federally guaranteed insurers and other insurers." The commission can compel production of "financial reports or records" including computer and EDP information, thereby giving it explicit authority to become, in effect, a regulator of the entire insurance industry. Although the commission may affiliate its early warning system with that of the states, it can also establish its own, thereby generating dual reporting requirements and all the attendant problemsdifferent accounting, different forms, different standards of adequacy, different investment limitations, etc.

Finally, to those unsuspecting candidates for federal charters, it should be pointed out that the promise of limited regulatory involvement of the Federal Insurance Commission includes virtually all authority over policies created under any state insurance law or regulation except with respect to premiums and rates. Section 203 (a) (4) provides that in order to commence business (and maintain the federal certificate) the contracts of insurance issued by the federal insurer must be "in compliance with any applicable laws or regulations of the state or states where such contracts are proposed to be issued."

In the last analysis, there can be little doubt that S.1710 amounts to nothing less than a deep opening wedge for complete federal regulation of the insurance industry. Whether explicitly provided in the language of the bill or not, as the DOT advisory committee put it "[c]omprehensive federal control will, indeed must, follow federal financial responsibility." "

Sec. 6(a) (4), S. 3884, 94th Cong. 2d Sess.

3S. 2236. 91st Cong., 1st Sess.

30

Statement of the Advisory Committee on Economic Regulations to the Department of Transportation Re: S. 2236.

Testimony of Paul Cherington. Assistant Secretary for Policy and International Affairs, Department of Transportation: Hearings on S. 2236, Before the Senate Commerce Committee. 91st Cong.. 1st Sess. (1969-1970).

See footnote 38, supra.

D. ILLUSTRATIVE TECHNICAL FLAWS IN S. 1710

At this point, I would like to turn to a few technical concerns with S. 1710. Because the implications of this bill touch virtually every aspect of the insurance business, my remarks can only be illustrative rather than exhaustive of our

concerns.

The structure of the proposed federal guaranty system and its operations as defined in S. 1710 suggest that the Federal Insurance Commission may have the power to intervene as a third party in determining policy content and conditions-without the need for judicial proceedings. According to Sec. 102(e), any "insurance obligations incurred or maintained, exclusive of the reinsured obligations of a ceding insurer . . . is guaranteed and, upon default of such insurer, such obligation shall be met by the Commission. . . ." The provision could pose tremendous coercive power over federally guaranteed insurers.

Rather than speaking of the guaranty fund kicking in upon impairment or insolvency of an insurer, Sec. 102 of S. 1710 provides for federal payment upon default. "Default" is not defined. Further, "guaranteed obligation" is defined to mean any insurance obligation to a policyholder, claimant, or assignee within "the coverage of the policy." This type of Commission power appears to clothe the new federal agency with unprecedented power to fulfill social objectives and reforms. In the event of a coverage dispute, the Commission could on its own conclude that a "default" had occurred and pay the disputed claim. In other words, coverage could be "deemed" to be included in any policy at the whim of the commission. If Sec. 102(e) means what it says, it would have unimaginable consequences for the insurance business.

Section 102 (f) also evidences some lack of understanding about the insurance industry and its operations. This provision suggests that the federal guaranty mechanism contemplates the assignment of insurance contracts of insolvent insurers. In closing banks, we understand FDIC arranges for assumption of deposits by other banks. According to paragraph (f), the Commission is to pay obligations when possible through the insurers to which policies have been assigned. Section 104 also repeats this assignee payment mechanism. If casualty policies of an insolvent insurer are to be continued through a federal commission assignment, the bank parallel again falls down because of the enormous insurance complications attendant to such an assignment. An insolvent insurer's difficulties may well be attributable to poor underwriting, insufficient premiums, or other reasons making policy assignments unattractive. Transferring casualty policies to other carriers would require some means of sweetening the assumption by other insurers or subsidizing the attendant losses on these underpriced coverages or bad risks. No provisions of S. 1710 even suggest the outline of such a transfer mechanism or necessary fair procedures.

We also note the exemption of "reinsured obligations" from those insurance obligations guaranteed by the federal fund. It should be understood by the proponents of this bill that it will most often not be possible to represent federally guaranteed policies as coverages backed up by an agency of the federal government in advertising or communications with the public. For example, a block of business may be reinsured on a pro rata basis with the writing carrier only retaining 50 percent of the exposure. If the writing carrier becomes insolvent, presumably only 50 percent of the policy obligations would be guaranteed by the federal government. Since the policyholder has no privity of contract with the reinsurer, absent an assumption or cut through provision in the reinsurance contract, the policyholder will apparently have to stand in line with other creditors before the liquidator for 50 percent of his claim. Reinsurers, of course, may or may not be federally guaranteed and the "partial" guarantee, where any coverage is reinsured, may prove unsatisfactory. Again, as the DOT advisory committee put it, the federal commission may find itself reaching "farther and farther in the exercise of powers conferred upon it or ... [seeking] even more powers." 40

Numerous other details of S. 1710 present serious concerns to state insurance regulators and betray the limited regulatory involvement suggested in explanatory comments by proponents. Those issues that we have raised, however, suggest the extent of technical and, conceptual flaws which will inevitably make this bill unworkable or require the federal system to operate substantially in derrogation of the existing system of state insurance regulation. Neither result is in the public interest.

40 Id.