preceding witness and boil your statements down, if possible, to 10 minutes because we have a number of questions we would all like to get into, if possible. Mr. Hunter, go right ahead. Incidentally, if you do that, we will have your statement printed in full in the record. STATEMENT OF JOHN ROBERT HUNTER, JR., DEPUTY FEDERAL INSURANCE ADMINISTRATOR, DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT, ACCOMPANIED BY HOWARD CLARK, FORMER INSURANCE COMMISSIONER, SOUTH CAROLINA

Mr. HUNTER. I have with me today Mr. Howard Clark, who is a former insurance commissioner of South Carolina and an expert on insurance regulatory matters from both State and Federal viewpoints. Let me make it plain at the very outset that we regard Senator Brooke's bill as one of the most significant contributions in the long dialog respecting State-Federal relationships referable to the regulation of insurance. The bill is unique in that it removes the dialog from the abstract and places it in the concrete setting of real problems which call for practical solutions. Senator Brooke has performed a real public service in introducing the measure, and your committee performs a similar service in providing this public forum.

In introducing this revision of the original bill, Senator Brooke has indicated his primary intention of fostering and furthering debate on the subject, particularly with respect to the concept of affording insurers an election whether to be regulated at the State level or to be regulated, in part, at the Federal level. We wholeheartedly agree with the wisdom of avoiding any suggestion that either the concept or the terms of the bill have been carved into granite. Much debate, great consideration, and further refinement are needed before we can even begin to consider the provisions of the measure as relatively fixed. Indeed, as Senator Brooke has himself stated, it may be that the conceptual design of the bill will have to be abandoned as unworkable, though we are far from predicting any such result.

There are two clearly separate concepts within the bill, the Federal chartering or dual regulation concept, and the solvency guarantee provisions. We shall focus primarily on the solvency protection features of the bill.

It is evident that the seed of the bill was planted when the insurers voiced their concern over the ripple effects stemming from the prospective insolvency of a major insurer-which fortunately did not come to pass-under the post-assessment features of the NAIC Model Act which makes provision for the assessment of participating insurers only after the occurrence of an insolvency. The insurers' understandable concern in this regard was exacerbated by the actual failure of the Gateway which constituted the largest failure of a single insurer in property-liability insurance history.

Under the present bill, the Federal solvency guaranty mechanism is open to all insurers who meet and comply with its standards, and such insurers thereby are immunized from participation in the State entities. We believe that this may well intensify the adverse selection factor and cast further doubts upon the ability of State guaranty mechanisms to survive. This matter is worthy of the committee's

closest consideration, and it may be that thought may need to be given to the desirability of preemption.

Mr. Chairman, the unfortunately long history of tight insurance markets and perennial insurance crises has been replete with examples of insurance interests taking advantage of the situation to amass volumes of business which they had neither the finances nor the will to absorb. In short, in too many instances, there emerged companies that were "formed to go broke." This is not at all intended to suggest that all, or even many, of the insurers specializing in so-called high-risk insurance are, or have been, predators, but the fact is that the history of insurer failures is filled with disasters wrought by those who were predators, optimists to a fault, or an unhappy combination of the two. Legislators and regulators at the State level beset by the political reverberations from a vagarious insurance market sometimes succumbed to the temptation to look the other way when danger signals flashed.

Successive crises or problems, if you prefer-in the medical malpractice, products liability, and other general liability lines of insurance suggests that market problems aplenty now exist, and that desire for relief from those problems is widespread.

In the light of the recent failure of an insurer which transacted the majority of its business as a surplus lines insurer engaged in miscellaneous liability business, we are frankly concerned that the NAIC Model Act and other State statutes that we have reviewed provide no relief to policyholders or seriously injured claimants of an insolvent surplus lines insurer. As we read the Model Act, it appears that if a surplus lines insurer issues its policies in a State other than that of its domicile, neither the guaranty association of the foreign State nor the guaranty association of the insurer's domicile will cover the claim of a seriously injured resident of the foreign State in the event of the insolvency of the surplus lines insurer.

As to the foreign State, section 4(a) of the Model Act defines an "insolvent insurer" in terms of "an insurer licensed to transact insurance in this State***" Thus, the nonadmitted surplus lines insurer is not an "insolvent insurer," within the meaning of the act, in the foreign State.

As respects the surplus lines insurer in its domiciliary State, section 3(a) of the Model Act stipulates that a claim is a "covered claim" only if the insurer became insolvent after the effective date of the act and "the claimant or insured is a resident of this State at the time of the insured event." It thus follows that the claim of the resident of the foreign State is not a "covered claim" of the guaranty association of the surplus lines insurer's State of domicile. This impresses us as an intolerable "catch-22" situation.

Interestingly, until 1973, the Model Act defined an "insolvent insurer" as "an insurer authorized to transact insurance in this State ***"but even then, most States apparently construed “authorized" as being synonymous with "licensed."

Let me stress that we do not for a moment suggest that the bulk of surplus lines insurers are in shaky financial condition; indeed, many are the surplus lines running mates of large, financially sound insurers. On the other hand, we are uneasy that even a relatively few

seriously injured claimants may be deprived of all hope of compensation through the insolvency of a surplus lines insurer many of whose risks have no protection from any guaranty mechanism.

We continue to be concerned that the Federal chartering provisions of the bill may lead to dual regulation with all its potential overlapping, duplications of effort and expense, and jurisdictional conflicts. We have yet to be convinced that form approval, which the bill clearly leaves to the States, is so divorced from financial or rating concerns that divided responsibility is either feasible or desirable. For example, in the form approval statutes of many States there is a provision under which approval of an accident and health insurance form may be denied or withdrawn if the policy's benefits are found not to be reasonable in relation to the premiums. The question may well arise whether such a provision is a rate regulatory measure from which the federally chartered insurer is immune or whether it is a policy form matter within the clear jurisdiction of the State authority. We believe that myriad such matters need to be very carefully sorted out in the study of the bill which Senator Brooke has wisely counseled.

We believe that close attention must be accorded the issue of insurers opting in and out of the Federal system from time to time. In our view, competition between the State and Federal regulatory systems could be very beneficial to the insuring public if this were competition for excellence, as we would hope and expect it to be, but if the rival systems were ever to compete with each other in weakness or the ignoring of consumer interest, the result would be as disastrous for the insurance consumer as the reverse competition which is the curse and shame of consumer credit insurance.

We have made no secret of our uneasiness growing out of that phenomenon of the insurance institution known as selection-competition, or the ability of the insurer to enhance its competitive position and its profits by being more selective in its underwriting acceptances than its competitors. The instituting by some insurers of such a course of action creates a sort of competitive determinism requiring other insurers to do the same, as some of the insurance redlining studies have shown. We have often quoted former New York Superintendent. of insurance Benjamin R. Schenck on the subject because of the aptness of his language. He said:

In insurance, however, there is one form of competition that seldom exists in the case of other products or services. That is selection competition--the ability of an insurer to affect its success, not by the price or quality of its products, but by selecting its customers in a fashion that will give it an advantage over its rivals. Selection competition is a feature of the insurance economy which seems to provide a ground for distinguishing insurance from other products and services and for fashioning for insurance a series of special rules unique to its problems and circumstances.

Selection competition should have few admirers. It is capable of totally denying to some people the opportunity to buy insurance at all in a day when many forms of insurance have become legal and practical necessities.

We would have no concern with the underlying theme of S. 1710 that the market is the better regulator if, but only if, the insurance consumer's right of selection is at least equal to that of the insurer. In short, we submit that a condition precedent to competitive rating must be the right and ability of every insurable consumer to select his

insurer and be written by that insurer on the same basis as every other risk falling within the same reasonable and objective risk classification. Only in such fashion can the advantages of competition be required to enure to the benefit of the insurance consumer.

As the committee surveys the entire spectrum of State-Federal insurance regulatory relationships, we venture the hope that the possibility may be explored of a mutually supportive and complementary relationship rather than one of rivalry or mutual exclusivity. There may be areas, for instance, of statistical and financial data gathering and compilation which are beyond the reach of individual State regulators in terms of resources or jurisdiction or both. State regulators might well welcome a Federal initiative in areas where there exists a

need for data.

We close, as we began, with praise for the committee in making this hearing possible. It has offered a golden opportunity for a fresh look at present and prospective State and Federal roles in the regulation of insurance.

The CHAIRMAN. Thank you very much.

Mr. Sims.

STATEMENT OF JOE SIMS, DEPUTY ASSISTANT ATTORNEY GENERAL, ANTITRUST DIVISION, DEPARTMENT OF JUSTICE, ACCOMPANIED BY GUY MASERITZ, CHIEF, LEGISLATIVE UNIT, ANTITRUST DIVISION

Mr. SIMS. Thank you, Mr. Chairman.

With me today is Guy Maseritz, who's the Chief of the Legislative Unit of the Antitrust Division, and principal author of the Department of Justice report which I will refer to later on in my statement. Pursuant to your invitation, I will significantly excerpt from my printed statement.

[Complete statement follows:]

STATEMENT OF JOE SIMS, DEPUTY ASSISTANT ATTORNEY GENERAL, ANTITRUST DIVISION

Mr. Chairman and members of the committee: I welcome this opportunity to testify on S. 1710, the proposed "Federal Insurance Act of 1977." This bill would establish a federal system for the guarantee of insurance obligations and the formation of federally chartered companies to be regulated by a new independent federal agency, the Federal Insurance Commission.

S. 1710 appears to be designed principally to improve "the quality of regulation for solvency." On this issue, the Department must defer to those who are more knowledgeable on the problems of state solvency regulation. Our teştimony today will deal solely with the narrower question raised by S. 1710whether a dual system of insurance regulation would be an appropriate alternative to state rate regulation for fostering price competition and restricting federal antitrust immunity. As you know, the Department advanced such a proposal in its January, 1977 report on "The Pricing and Marketing of Insurance", as one possible approach to fostering competition in the insurance industry. I should emphasize that the Administration has not adopted a position on the issues raised by the report.

We are pleased that this Committee will be considering many of the difficult public policy issues raised by a legislative proposal designed, in part, to reconcile the public interest in a fully competitive system with the regulatory objective of a reliable insurance mechanism. I will outline today the findings of our limited study and what we see as the principal competitive issues raised by this legislation.

A. THE DEPARTMENT'S FINDINGS

In our study, initiated because of the existing antitrust exemption for the business of insurance, we sought to determine whether thirty years of state regulation has been adequate alternative to competition-i.e., whether state regulation (and antitrust immunity) has produced the benefits ordinarily expected from competition: reasonable prices based on the cost of rendering the services; efficient services rendered at the lowest possible cost; and innovation (the utilization of new or improved products or services and methods of distribution).

The Department's study focused principally on the pricing and marketing of property-liability insurance, particularly private passenger automobile insurance and commercial fire insurance. These two lines of insurance appear to raise most of the basic issues concerning the effects of rate deregulation and imposition of federal antitrust restraints on the business of insurance. We also briefly examined certain other lines of insurance raising special problems, such as "reverse competition," which I will discuss in greater detail later in this statement.

Over the past ten years, there have been a number of states that have adopted an "open competition" system of rate regulation after attempting to administer a highly regulated system. This experimentation with competitive controls is evidence of the inadequacies of state rate regulation. Moreover, the emergence of independent pricing in segments of the property-liability industry, despite restrictive state laws, may be attributed to an industry favorably structured for competition, to certain inherent weaknesses in rate regulation, to the successful experimentation with rate deregulation in a number of states, and to the continuing Congressional investigation into insurance industry practices.

Our studies of the effects of rigid rate regulation in automobile insurance indicate that such regulation has fostered greater adherence to bureau rates, discouraged rate reductions, contributed to instability in insurance company operations, established various forms of cross-subsidization between good and bad drivers, imposed unnecessary restrictions on the collective merchandising and the direct writing of insurance, and aggravated the availability problem, in which marginal or high risk drivers have difficulty obtaining coverage in the open (or "voluntary") market at the prevailing rates.

On the other hand, the long-run experience of at least one major insurance state under an open competition system, in which the state has relied on market forces to control prices, suggests that unrestricted price competition can provide a most effective substitute for rate regulation in obtaining the benefits normally expected from competition-reasonable prices and maximum efficiency in the sale and distribution of insurance.1 A comparison of the experience of the same insurers under certain open competition and "prior approval" systems suggests that competition fosters independent pricing, operating stability, and flexibility in the pricing structure. The relatively favorable performance of the insurance companies themselves under the more competitive system suggests that it provides a more effective mechanism for accomplishing the basic insurance goals of a reliable insurance mechanism and generally available coverage at a price reasonably related to cost.

In the commercial lines, we found that state regulation is largely illusory and that insurers are generally free to set their own prices, largely because of the availability of state-authorized rating plans, which permit insurers to individually price risks based on their business judgment and competitive pressures. The prevalence of these plans--which generally supplant regulationraises an obvious and fundamental question as to the continued need for state rate regulation in these lines of insurance.

Finally, we believe that the industry should be able to conduct its business without any special exemption from the federal antitrust laws. Antitrust precedent indicates that insurance companies could pool their loss experience through a statistical bureau consistent with federal antitrust standards. Moreover, we believe that the federal antitrust laws would not prohibit any necessary trending of future losses on a composite basis by advisory organizations that were

1 See also New York Insurance Department Report on "The Open Rating Law and Property-Liability Insurance" (1977), at vi; and Illinois Insurance Department "Automobile Insurance Rate Study" (1977), at 5-6.