STATEMENT OF MASSACHUSETTS INSURANCE COMMISSIONER JAMES M. STONE

Mr. Chairman, I appreciate the opportunity to comment this morning on Senate Bill 1710. In my view, Senator Brooke's bill to permit Federal chartering of insurance companies has already accomplished something of importance. It has fostered a long overdue debate on the appropriate Federal role in insurance regulation. While I can not urge passage of Senate 1710 as it is presently drafted, my opinion of the bill is essentially favorable. I can not share the sentiments of those state Commissioners who feel that any Federal scrutiny of the insurance business represents an unwarranted encroachment upon the rights of the sovereign states. On the contrary, I regard an increased Federal presence in the regulation of insurance as both inevitable and desirable.

To those unfamiliar with the subject, it must be a source of some mystery that the insurance business is not already regulated on the Federal level. The reason lies in a quirk of history. In 1869, the United States Supreme Court, in Paul v. Virginia, ruled by some abstruse logic that the business of insurance was not "commerce". If insurance was not commerce, of course, it certainly could not be interstate commerce, and thus there was no constitutional authority for Federal regulation. Accordingly, when the Sherman Act and the Clayton Act were passed many decades later, insurers were automatically presumed to be excluded.

Insurance was similarly left out when the New Deal brought the second great wave of regulation. Under this peculiar umbrella of protection, insurance companies were free for many years to violate with impunity the anti-trust and business practice standards which bound virtually every other industry. Had it not been for Paul v. Virginia, there would very likely be a Federal Insurance Commission today, and Senate 1710 would be unnecessary.

The legal environment changed dramatically for insurance companies in 1944. The Supreme Court reversed its earlier position and declared, in United States v. South-Eastern Underwriters Association, that insurance had, in fact, been commerce all along. To hold off a Missouri indictment of twenty-seven insurance executives for criminal anti-trust violations, Congressional protection had to be sought by the industry. A massive lobbying effort was constructed and Congress responded in 1945 with the passage of the McCarran-Ferguson Act. McCarranFerguson restored the exemptions of insurance from the Federal Trade Commission Act and most of the Sherman and Clayton Acts, but only to the extent that insurance was regulated under state law. Continued state regulation was thus reinforced by specific Congressional action. A nineteenth century court decision and a twentieth century legislative act constitute the principal reasons why insurance today remains the largest national industry subject primarily to regulation at the state level.

Since the passage of McCarran-Ferguson, state regulation has held undisputed primacy in matters of insurance. The arguments for a Federal presence, though, have never quite been stilled. It is generally agreed that the Federal government could provide a useful standardization across state lines in most aspects of the regulatory function. It is widely accepted that Federal jurisdiction would more closely match the interstate nature of the regulatees. The economies of scale that would result from a single regulatory agency instead of fifty are hard to dispute. To these arguments I would add one more. The active scrutiny of the national press corps tends to provide a better shelter at the Federal level against incompetence and inappropriate influence than exists at the local levels. Arguments for continued state regulation usually revolve around the need for flexibility and experimentation from state to state. Companies, and some consumer groups, feel that they have more access to regulators on a localized basis than they would in Washington. The issue is not easily resolved in abstract terms.

A functional analysis of the work of Insurance Departments provides some useful specificity. Our work in the Massachusetts Department can be divided into three categories, each potentially different with respect to the appropriate Federal role:

First, there is Solvency Protection and Company Licensing. Budget allocations for this function have traditionally been higher than for all our other jobs combined. We must evaluate every new applicant wishing to do business as an insurer.

We examine every licensee on a triennial basis. We seek to prevent insolvencies and, if unsuccessful, we must manage the receiverships. In my judgment, there is every reason to believe that the Federal government could do a better job. State examining personnel are chronically underpaid almost everywhere. Pre-licensing examinations are redundantly performed up to fifty separate times. The various

states squabble over control and order of payment whenever an insolvency occurs. Truly interstate businesses ought to be Federally chartered and examined.

Senate Bill 1710 is soundly drafted with respect to examinations and insolvency protections. The framework for the independent regulatory commission it proposes is far superior to the present construction of the Federal Insurance Administration. The Federal Insurance Guarantee Fund it would establish is sorely needed to coordinate interstate receiverships and to assure coverage in those states without insolvency funds.

A second set of Insurance Department duties relates to the Monitoring of Business Practices of companies and agents. The Massachusetts Department deals with over 10,000 consumer complaints every year. Some are resolved when the applicable law and contract terms are carefully explained to the consumer. Others trigger informal or formal settlement hearings. The most serious result in investigations by our staff and ultimately may lead to disciplinary actions. The Department continually surveys insurer advertising and examines policy forms for truthfulness and clarity.

In these areas, there is a less compelling need for Federal assistance than in protection against insolvency. I cannot fault Senate Bill 1710 for leaving the supervision of business practices, at least for the immediate future, at the state level. On some later occasion, were this bill to become law, I would probably recommend that the Federal Insurance Commission be authorized to look at the interstate business practices of insurers. Too many improper practices are repeated in state after state, and too much jurisdiction confusion arises when improprieties are conducted across state lines.

Rate regulation in the casualty lines comprises the third element of Insurance Department responsibility. It receives the lion's share of public attention and it is, by far, our most difficult task. Commissioners must not only seek to prevent insurers from reaping excess profits; they are also charged with maintaining markets where insurers are unwilling to write and with assuring that the relative rate structure for all policyholders is fair and non-discriminatory. Senate Bill 1710 would take a step forward by repealing the McCarran-Ferguson anti-trust exemption. There is little evidence that state regulation holds down overall profit margins more effectively than would vigorous anti-trust enforcement. Unfortunately, though, Senate Bill 1710 would take a step backwards in freeing insurers from state laws which regulate relative rate structures outside of the compulsory pools and assigned risk plans.

This year has seen a great turmoil in Massachusetts concerning the price of automobile insurance. My experiences in recent months have persuaded me that competition among insurers is not, and may never be, sufficient to assure an equitable rate structure. Insurance prices are not marginal cost prices. They are crude estimates of future cost based on group statistics. I am not convinced that young males with perfect driving records should pay more than young females just because a relatively small fraction of other males have poor driving records. I am not convinced that urban residents should bear the burden of commuting traffic which raises the likelihood of their being involved in collision accidents. I am not convinced that the honest people of our cities should pay the full freight for the social problem of urban crime, which raises the cost of theft insurance.

New thought is evolving around the country on these issues. The Massachusetts Department intends to study them carefully at a hearing to be held next month. Senate Bill 1710 would remove the state's authority to demand a fairer rating structure. This is one case where, during a period of evolutionary thought, state-by-state experimentation is extremely valuable. Federal law might be useful some day in mandating an equitable rate structure. It is counterproductive if it freezes in the status quo. Senate Bill 1710 would be a better bill if it simply deleted the sections dealing with rate regulation.

Mr. Chairman, I urge you to approach Senate Bill 1710 with an open mind. Do not be overly concerned that Federal regulation of insurance appears to contradict historical precedent. Do not be overly calmed by those who would assure you that all is well with regulation by the fifty states. Federal scrutiny of the insurance business, particularly with respect to its financial soundness, should have been established long ago.

With me this morning is Deputy Commissioner Keith R. Rodney of the Massachusetts Insurance Department. Mr. Rodney's responsibilities with the Department include supervision of our entire examination and solvency protection effort. He is a C.P.A. by background and just this summer served as receiver in the successful rehabilitation of a troubled domestic life insurance company. His

comments may be useful to the Committee in documenting the advisability of a Federal presence in the areas he handles.

STATEMENT OF MASSACHUSETTS DEPUTY COMMISSIONER OF INSURANCE KEITH R.

RODNEY

Mr. Chairman and Committee Members, I support the sections of this bill which deal with the regulation of insurer financial soundness. The regulation of the financial stability of companies doing interstate business and the administration and funding of insolvencies should not be done on a fragmented state-by-state basis. The present fifty-state regulatory structure acts to complicate the process of regulation and adds significant duplicative costs. Proof of the system's weakness is easy to find. State audits were not effective in identifying or preventing the insolvencies of Equity Funding, Gateway or twenty-one other companies in the last several years.

The states are not likely to remedy the problems which account for their lack of success in this area. State examiners' salaries are often insufficient to attract competent auditors. The average entry level salary is approximately $11,000 in New England Departments. This compares with approximately $15,000 offered by private CPA firms. There is no easy solution to the jurisdictional disputes over examinations. Many states are free to participate independently in each audit. This often results in the performance of costly and unnecessary repetitive audit work. An even greater justification for federal financial regulation becomes apparent when companies are in financial difficulty.

In 1975, the Summit Insurance Company became insolvent and a receiver was appointed in New York. Most other states appointed ancillary receivers and hired counsel to be paid out of Summit's assets. The ancillary receivers fought over payment priorities so New York had to hire local counsel in several states, including Massachusetts. They were also paid out of Summit's assets. As a result, payments to Summit policyholders were delayed for many months. An unreasonable share of Summit's assets was consumed by the jurisdictional disputes.

Two weeks ago, the Empire Mutual Insurance Company was placed into rehabilitation and declared insolvent in New York. Only New York State policies now remain in force and only claims by New York residents will now be paid. Out-of-state policies are being cancelled and no claims are being paid. Yet, many state insolvency funds are refusing to pay the claims in their states because the company is not being liquidated. As of today, there is no mechanism for paying a penny to non-New York policyholders.

We are fortunate that there has not been a major life insolvency in recent years. Most states, including Massachusetts, provide no insolvency protection at all for life and health insurance. Unpaid policyholder claims in these lines would produce personal catastrophes far worse, in many cases, than those in casualty lines.

The Federal Insurance Guarantee Fund suggested by Senate 1710 is an excellent model for better consumer protection. Like the Federal Deposit Insurance Corporation in banking, it would provide far better financial security for the public than any state system is ever likely to do.

The CHAIRMAN. Well, thank you very much. I take it—what is your name, sir?

Mr. HASTEN. I'm Michael Hasten, general counsel for the Department of Insurance for Illinois.

The CHAIRMAN. Fine. I take it you have no statement?

Mr. HASTEN. No, Senator.

The CHAIRMAN. All right. The witnesses that we have here certainly provide a good variation in view, which is very healthy and useful. I want to once again congratulate Senator Brooke on introducing this bill. I'm not a cosponsor of it. I may oppose it, but I think it's an excellent initiative to provoke the kind of full-fledged open debate on the problems involved that we have needed. We haven't done this and I think we now have an opportunity to do it.

Furthermore, it's not a mandatory proposal. It's a voluntary proposal. No insurance company is forced to become regulated by the Federal Government. They can volunteer if they wish to do so, as I

understand it, to get a Federal charter and then they would be under Federal regulation.

Furthermore, it has the great advantage, as I see it, of providing for those insurance companies that do opt to go Federal to be subject to antitrust laws and therefore to provide a greater degree of price competition to the benefit of consumers than we have had in the past.

Having said all that, I wonder if we do have much of a case really for a new Federal agency to step in on this basis. We have the cost issue Mr. Kinder so ably expressed and I would like to ask first, Mr. Stone, if we really have-in relationship to the size of this industry-after all, with premiums of $57 billion a year-do we really have any kind of record of abuse, record of loss, that would warrant a new initiative of this kind? Isn't this an industry that functions rather well in spite of the antitrust limitations still with quite vigorous competition? What is the case under these circumstances for moving or having the Federal Government move in with all the shortcomings and weaknesses that Federal regulation has exhibited in the past in so many areas?

Mr. STONE. Well, Mr. Chairman, if the standard for establishing a Federal agency was that there had to have been a disaster or there had to be a disaster pending, I guess I would say that there is not a strong case. I think that the case is based more on the commonsense and efficiencies of some standardized regulation rather than any potential disaster.

I would think that there's a good case for having a Federal regulatory presence any time you have a business which is as large as this one, which demands regulation at some level of government as this one does, and which is so truly interstate in nature.

I'm not certain that the burden of proof should be so high as you suggest.

The CHAIRMAN. Well, the only concrete data that I have seen, Senator Brooke pointed out there was a $7 billion or $8 billion casualty loss. Mr. Rodney has referred to the Empire casualty failure and the fact that some policyholders are losing. It would seem that there should be, in an industry as comprehensive and covers literally millions of American businesses and families, a clear documentation of need than we have here for this kind of additional departure.

In view of the arguments that the other gentlemen have made that we are trying to move against unnecessary agencies with sunset laws and trying to end regulation where we have it and trying to eliminate redtape and duplication as much as possible

Mr. STONE. Well, I can't give an answer that meets that standard, but I guess I feel that a stronger a priori case exists for Federal regulation than these do even for State regulation; that if there were no regulation at all of insurance and we were trying to construct the most reasonable regulatory system, we would probably set it up on a Federal level. So much of the business is interstate, particularly the financial practices and insolvency work, that it would seem to me that it was only because of what I think was essentially a mistake of the U.S. Supreme Court in the 19th century that this didn't happen in the first place.

The CHAIRMAN. Well, you can say that. The absence of action on the part of Congress and on the part of Presidents of the United States failing to call for this for over 200 years has indicated that that

need wasn't perceived. As you know, there's been an awful lot of progressive, reform-minded Congressmen and Presidents in the past. Franklin Roosevelt never called for it. Woodrow Wilson never called for it.

Mr. STONE. They couldn't have. Only after 1944 did the U.S. Supreme Court recognize that insurance was interstate commerce. The CHAIRMAN. You've got John Kennedy and Lyndon Johnson and a lot of other fine Democratic Presidents.

Mr. STONE. Yes; that's correct.

Senator SCHMITT. Would the Senator yield?
The CHAIRMAN. Yes.

Senator SCHMITT. I'm not so sure Franklin Roosevelt worried about the Supreme Court in the early days. [Laughter.]

The CHAIRMAN. Well, Mr. Kinder. I think Mr. Stone has made some good points, as has Senator Brooke. After all, this is a huge, huge business and to pretend it doesn't represent interstate commerce is pretty unrealistic. The largest corporation in our State of Wisconsin, for instance, is Northwest Mutual Insurance Co. with over $7 billion in assets-mammoth-dwarfs the banks and everything else and, of course, it's clearly an interstate commerce. There's no question about it, at least in interstate relationships.

Yet these firms are regulated only at the State level. Isn't it inefficient, ineffective for 50 different States to examine and license the same large companies over and over again with differing approaches, differing views, differing rules? Doesn't it make sense in that way to provide at least an option on a voluntary basis for a truly national insurance company-and so many of them are-to go national? Why wouldn't that be a reasonable approach?

Mr. KINDER. Well, I believe that since these others are in place and have been functioning that the introduction of the Federal effort would be an additional set of rules which each of the companies plainly would be subject to and it would add further to that work effort that you described.

I believe that once a company has gone through the admission process in the several jurisdictions it does not find the renewal process-that is, the subsequent examinations and renewal of its certificate of authority in the different States-to be a particularly onerous burden. I think if that were true and the insurers believed that a single regulatory agency would provide relief from a heavier burden, that they would be here urging the adoption of this legislation.

The CHAIRMAN. Do you agree with that, Mr. Stone? Do you feel there wouldn't be an elimination of some duplication if we had the Brooke bill law? Wouldn't it be, to some extent at least, an opportunity for firms to come under a Federal regulation? Wouldn't they be able to escape from some of the duplicating restrictions that they have got with 50 States?

Mr. STONE. One of the reasons that I'm attracted to parts of this bill is that I would assume that if the Federal Government were performing examinations that some of the examination load now on the States would be lifted. Both from the point of view of the companies and from the point of view of the State treasuries, that expense and that burden would be gone because the Federal Government would