For Your Consideration

Folks, get ready to hear more about the McCarran-Ferguson Act in the coming days and weeks as it is now in the crosshairs of our elected representatives in Congress and may quite simply become a casualty of the health care “reform” push. I’m going to try to briefly separate fact from fiction and address some of the “spin” I’m reading in the current misguided push to repeal this federal law.

What you absolutely need to know about McCarran-Ferguson is that it allows each of the states to regulate the insurers that write business within their state. So, instead of one regulator in Washington looking at the industry, there are 50 regulators! McCarran-Ferguson also grants insurers a VERY LIMITED exemption to federal anti-trust laws. The law’s Wikipedia entry is here and if you’re particularly adventurous, here is the text of the law itself.

Now, the general effect of McCarran-Ferguson on insurers is that it allows the sharing of statistical loss data and loss experience (usually called “prospective loss costs”) over the entirety of the industries they serve. So, for example, a health insurer writing business in Washington, DC can review an amalgam of all losses of all health insurers within that jurisdiction.

McCarran-Ferguson does not allow insurers to get together in smoke-filled star chambers and price-fix the cost of coverage for the ultimate consumer. That, friends, is completely untrue, utter nonsense and political spin. Federal laws such as the Sherman Act (and other such anti-trust laws) were enacted to prevent this type of illegal activity and McCarran-Ferguson does not supercede these laws. So, to reiterate, collusion to fix prices and so called “tying” arrangements are illegal and McCarran-Ferguson does not allow them to occur, no matter what you read on the internet.

It does allow (in concert with certain legal decisions in the 1980s) insurers to share actual loss data in the aggregate.

Why this is important is because the accuracy of an insurer’s prediction of losses increases as the size of the data sample increases. In essence, the sharing of loss data increases “credibility” (both statistically-speaking and in the real world). In fact, it’s this mathematical concept, commonly referred to as the “Law of Large Numbers“, that allows insurance to be viable.

So, to the extent that losses are forecast more accurately, the premiums charged better reflect the actual exposure to loss. In plain language, fairer and more accurate pricing of coverage is possible because the insurer has a larger, more credible sample of loss data to draw upon, rather than trying to price coverage based upon its own (very limited) loss data/experience.

Further, in political parlance, one can see how McCarran Ferguson actually promotes “choice and competition” as it allows insurers which do not have experience in certain lines of coverage to offer products with more relative certainty of the losses they are likely to see. Without the relative certainty large loss data samples afford an insurer, it may simply decide not to enter new markets, thus depriving consumers of a potentially competitive choice.

Also, the sharing of loss data promotes stability of insurers, reinsurers and society as a whole as it offers greater relative certainty that pricing is adequate for the exposures to loss assumed. The singular benefit to the consumer and society is that these stakeholders can be reasonably assured that the insurer will be “there” when losses occur and are required to be paid.

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Repeal of McCarran-Ferguson will undoubtedly have many unintended negative consequences. It is not difficult to envision that restricting an insurer to its own loss data will likely cause a contraction in not only the availability but also the scope of coverage provided by insurers. Many carriers may simply cease offering certain types of insurance or cease offering insurance to certain classes of business as they cannot assess their risk adequately.

If the above occurs, it will likely increase the cost of insurance, not only becase insurers will less credible loss data to base their pricing decisions upon (and have a greater cost of uncertainty) but also because there will be aggregate less competition amongst insurers, both of which ultimately results in fewer choices for consumers.

It is said that truth is the first casualty in war. In this war of words, at least understand what the truth is.

This entry was posted on Wednesday, October 21st, 2009 at 18:16 and is filed under Insurance. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.