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Under the McCarran-Ferguson Act, the antitrust laws are inapplicable to activities constituting the "business of insurance" but only "to the extent that such business is not regulated by State law," and provided that the challenged activity is not "boycott, coercion, or intimidation."  When an insurance company invokes the protections afforded by the McCarran-Ferguson exemption, the courts must determine that the federal statute involved "specifically relates to the business of insurance."  If it does not, the court then considers whether the activity in question is within the "business of insurance"; and if so, whether application of federal statute would "invalidate, impair or supersede" state law. 
The McCarran-Ferguson Act, however, does not define the "business of insurance." The courts have analyzed three factors when determining whether a particular practice constitutes the "business of insurance." In Pireno, the court analyzed: "first, whether the practice has the effect of transferring or spreading a policyholder's risk; second, whether the practice is an integral part of the policy relationship between the insurer and the insured; and third, whether the practice is limited to entities within the insurance industry." 
Interpretation of what constitutes "the business of insurance" is not limited to judicial opinions. According to a report from the Government Accountability Office ("GAO"), the business of insurance entails: jointly setting agent commission rates; fixing rates pursuant to joint agreements and ratings boards; classifying and re-classifying risks; agreeing to pay damage claims based on agreed-upon labor rates; limiting or refusing to offer certain types of coverage; and, jointly undertaking activities to limit risks - including by revising policy language. 
The McCarran-Ferguson exemption has been judicially narrowed over the past 60 years.  Courts have distinguished between the general federal regulatory exemption of the McCarran-Ferguson Act and the separate exemption for the federal antitrust legislation.  Cases involving the applicability of the Sherman Act to insurance practices regulated by the states take a narrower approach to the phrase "business of insurance" and apply the three criteria laid out in the Pireno case. 
However, it is important to note that a court has held that even if a challenged practice constitutes the business of insurance and is regulated by the states, qualifying the practice as exempt from antitrust liability, the exemption is forfeited if the practice involves a third party outside the insurance industry.  The court in Royal Drug held, "an exempt entity forfeits [its] antitrust exemption by acting in concert with nonexempt parties." 
D. Judicial Interpretations - What does it mean to be Regulated by the states?
Section 2(b) of the McCarran Act makes the Sherman, Clayton, and Federal Trade Commission Acts applicable to the business of insurance "to the extent that such business is not regulated by State law."  Some have concluded that the McCarran-Ferguson Act should be construed to require adequate and effective state regulation before insurance is exempt from the antitrust statutes. 
The federal courts, however, have repeatedly allowed the exemption to apply upon a showing that "a State statute generally proscribes or permits or authorizes certain conduct on the part of insurance companies."  Moreover, the Supreme Court has declined to decide whether the quality of state regulation should be relevant under section 2(b). 
In addition to the state legislation regulating insurance companies, all 50 states have some type of state antitrust statute.  The States are not uniform in their antitrust scrutiny. Some States follow Federal law, others exempt insurance from State antitrust law to some extent, and still others have no exemption at all. 
There are some questions whether the states are effective at regulating insurance companies through their antitrust statutes. A 2005 New York-led investigation of several large national insurance firms, including AIG, uncovered extensive bid-rigging, collusion, and other anticompetitive practices. 
However, "[t]his is not just New York State's problem, it is a pervasive national problem."  In many states, the insurance commission does not have the capacity to regulate or prosecute any anticompetive behavior by insurance companies. A 2009 Center for American Progress survey of actions by state insurance commissioners found only limited and sporadic enforcement by state insurance commissioners.  In addition, there were no antitrust actions brought by state insurance commissioners. 
Furthermore, the states' limited jurisdiction makes it difficult to effectively regulate an international insurance company. One such insurance company that may not have been as effectively regulated as possible is AIG.
The AIG Crisis: Too Big to Fail?
AIG is a large, complex insurance and financial services conglomerate with business lines spanning from general and life insurance to complex financial transactions.  AIG's roots can be traced back to 1919 when Cornelius Vander (CV) Starr founded an insurance agency, American Asiatic Underwriters ("AAU") in Shanghai, China.  What started as a primarily international based company eventually came to the United States when American International Underwriters ("AIU") was opened in New York in 1926, and the AAU headquarters were moved there in 1939.  Through a series of acquisitions, AIU eventually became American Home, M.R. "Hank" Greenberg was appointed president, and AIG was officially formed in 1967. 
AIG Mergers and Acquisitions: From Insurance Giant to Multinational Financial King
Under Hank Greenberg, AIG continued to make various acquisitions, expanding its presence both nationally and internationally.  Since 1960, AIG has participated in "nine big [mergers]."  Because AIG is an insurer, and as discussed above is exempt from federal antitrust oversight, their numerous large mergers and acquisitions were not subject to "serious merger review," which is undertaken to stop anticompetitive monopolies from being formed. 
Section 7 of the Clayton Act aims to curb anticompetitive mergers.  As discussed above, insurance companies are not subject to federal oversight, when there is a state law that would regulate the business of insurance. While there is no clear guidance on whether the Sherman and Clayton Antitrust Acts apply to insurance, the "safest assumption is that insurance mergers are subject to . . . the substantive prohibitions of the antitrust laws. 
However, at one time it was believed that, even in the absence of the antitrust exemption, "[m]ost insurance mergers should survive scrutiny . . . because most insurance markets are unconcentrated."  However, this principle seems to only apply to horizontal mergers, or mergers between direct competitors.
During this time of expansion and for nearly 80 years, AIG was solely involved in the insurance business. However, two of AIG's major mergers and acquisitions moved AIG from being a "successful, rock-solid commercial property and casualty insurer" to a large financial conglomerate.  In the case of the AIG mergers and acquisitions, they would be considered vertical mergers, which tend to not draw the attention of the antitrust enforcers, despite changing the inherent nature of the business. 
In 1998, AIG acquired SunAmerica, a large financial firm that specialized in retirement savings.  In December 1999, AIG further ventured into financial services and became a thrift holding company, when the Office of Thrift Supervision ("OTS") approved its application to charter AIG Bank.  In 2001, AIG purchased American General, an enormous life insurer and consumer loan company. 
AIG was no longer solely an insurance company; it was a global financial giant that offered products far outside the scope of the business of insurance.  These two acquisitions and entry into banking greatly changed the structure and operations of AIG.
One such structural change was that AIG now owned a thrift holding company, AIG Bank, and it could elect to have OTS as its regulator.  Under the Gramm-Leach-Bliley Act of 1999  , certain companies could elect to be regulated by the OTS, provided they owned at least one thrift, or savings-and-loan.  With the creation of AIG Bank, AIG was using a loop hole in the Gramm-Leach-Bliley Act to further expand its business lines, under the supervision of OTS. 
OTS's oversight duties expanded when European regulators in January 2007 conferred upon OTS the authority to supervise the company's overseas operations, including AIG Financial Products (AIGFP), a London-based subsidiary. 
AIGFP: Investing in Credit Default Swaps and the Beginning of the Collapse
AIGFP was founded as a joint venture in 1987 by three former Wall Street traders who had experience in derivative trades.  In 1993, the joint venture ended, and AIG operated AIGFP as a fully owned subsidiary.  What AIGFP aimed to do was assist investment banks, governments, municipalities and corporations in devising "methods to free up cash, get rid of debt, and guard against rising interest rates or currency fluctuations." 
AIGFP used the AAA credit rating  of AIG to enter into these derivative transactions.  Because AIG was rated AAA, it did not have to post as much collateral on the derivative contracts it wrote, which made them much more profitable.  By 1998, AIGFP had annual revenue of $500 million. 
That same year, JP Morgan approached AIG and proposed that they insure JP Morgan's complex corporate debt.  With this, AIGFP first began to engage in credit default swaps.  AIG believed that they would never have to pay out on the deals, as the company never expected that JP Morgan would default, unless there was a full-blown depression.  And even in that instance, it was believed that all counter-parties would be eliminated as well, and no one would be demanding payment. 
However in 2005, following an investigation by the New York Attorney General, CEO Hank Greenberg departed AIG.  In response to Greenberg's departure, as well as the NY state investigation into AIG's questionable business practices, the credit rating agencies downgraded AIG's rating from AAA to AA.  This downgrade triggered provisions in some of the credit default swaps AIGFP had entered into, causing AIGFP to owe $1 billion in collateral payments. 
After this, AIGFP realized that the majority of its $80 billion of debt obligations were tied to sub-prime mortgage; the risk of default would be high if the housing market would collapse.  By summer 2007, the housing market had begun to collapse, and certain counter-parties began to demand collateral to cover the securities that the credit default swaps had insured. 
On September 16, 2008, AIG's credit rating was going to be downgraded again.  When its credit rating was downgraded further, AIG was required to post additional collateral with its trading counter-parties, and this led to a liquidity crisis.  AIG could not cover the calls for collateral made by its counterparties.
The insurance industry giant that was hailed as "too big to fail" was on the brink of a collapse that could have caused a ripple effect on their counterparties.  The next day, the United States Federal Reserve Bank announced the creation of a secured credit line of $85 billion to prevent the collapse of AIG. 
At the time of AIG's near collapse, many were saying that the housing collapse was the cause of the crisis.  However, had it not been for the "intricate financial contracts known as credit default swaps," the system may not have been as vulnerable.  As the primary regulator of AIGFP, OTS was responsible for regulating the high risk credit default swaps. 
However, in the days and weeks that followed the near collapse and subsequent bailout, most news outlets did not mention the failure of OTS to properly oversee AIG's use of credit default swaps. 
It wasn't until a Congressional Hearing in March 2009 that OTS finally stepped up and accepted blame for the meltdown. In testimony, interim director of OTS Scott Polakoff stated that "[i]t's time for the OTS to raise their hand and say they have some responsibility and accountability here. We were deemed an acceptable regulator for both U.S. and domestic and international operations."  However, it is clear that even though OTS was deemed an acceptable regulator, their oversight was lacking.
AIGI: The Other Side of the Coin: Securities Lending
While AIGFP was dealing in risky derivatives under the apparent oversight of OTS, the insurance units of AIG were involved in securities lending by AIG Investments ("AIGI").  AIG's securities lending practice was "the program whereby AIG lent securities held by its life insurance subsidiaries to hedge funds which in turn shorted the stock."  AIG invested the money it received from those securities and invested in high risk mortgage backed derivative instruments. 
The Federal Reserve and other regulators typically see securities lending as a "business with few risks."  However, like AIGFP, AIGI's securities lending practice had a large exposure to subprime mortgage related assets. State regulatory filings show that the securities lending units used almost two thirds of its $78 billion in cash collateral to buy mortgage backed securities. 
In September 2008, at the same time as AIGFP was suffering its own problems, borrowers in the securities lending program wanted a return of their cash collateral.  "Because of the illiquidity in the market for [mortgage backed securities], they could not be sold at acceptable prices, and AIG was forced to find alternative sources of cash to meet these requests."  The Federal Reserve Bank of New York made available $44 billion to help resolve the securities lending program. 
Unlike the AIGFP credit default swaps which were regulated by OTS, the AIGI securities lending program was regulated by the State insurance regulators.  Even after AIG had almost imploded, had it not been for the injection of cash from the Fed and from the Federal Reserve Bank of New York, the state regulators still didn't agree that the securities lending practice needed to be better regulated.  In addition, the state regulators insisted that it was only AIGFP which attributed to the near-collapse of AIG. 
Even in a March 15, 2009 release which detailed the payments AIG made to its counterparties, $66 billion went to AIGFP (about $54 billion of which is related to the credit default swaps); but the state regulated insurance businesses lost about $43.7 billion in losses on securities lending transactions.  That same month, Joel Ario, the insurance commissioner of Pennsylvania, wanted to "clarify the difference between the financial products which are regulated -- to the extent it was regulated at all, by the federal government -- and the insurance companies which are regulated by, we think, a very effective state-based regulatory system." 
Further, Eric Dinallo, Insurance Commissioner for the State of New York, stated "AIG securities' lending was consolidated by the holding company at a special unit it set up and controlled. This special unit was not a licensed insurance company. As with some other holding company activities, it was pursued aggressively rather than prudently." 
Incidentally, the Texas Department of Insurance acknowledged the securities lending practice and the investments in risky mortgage related securities. According to an analyst, the Texas Department of Insurance was "aware of this portfolio, but . . . didn't have transparency on what was in it because it was off-balance sheet in the company's statutory accounting reports." 
State regulators were quickly realizing the extent of AIG's liquidity crisis were beyond state regulators' ability to handle appropriately.  Both the states and the federal government were limited in their ability to effectively regulate AIG.
Solutions to the Problem: Repeal McCarran Ferguson and/or Federal Regulation
Throughout the years, there have been many attempts to amend or repeal the McCarran-Ferguson Act. However, past proposals to transfer regulatory authority back to the federal government have been successfully opposed by the states and the insurance industry. 
These past proposals were directed at correcting "perceived deficiencies in state regulation."  However, they failed due to "pledges from state regulators to work for more uniformity and efficiency" in the state regulatory process. 
Repeal McCarran-Ferguson - Application of Sherman & Clayton Acts
A major effort towards overhauling the regulatory structure of insurance companies began in the mid-1980's.  Several hearings were held and proposals were made to create a federal regulatory body modeled after the Securities and Exchange Commission ("SEC").  Again, the states and the insurance industry instituted reforms for new standards, and federal regulation was defeated.
After the state attention to instituting reforms, Congress' general attention on insurance regulatory matters decreased during the second half of the 1990's. However, in more recent sessions, Congress has begun to may more attention to evaluating the regulatory structure of insurance.  From the 107th through the 110th Congresses, the House Financial Services Committee held several hearings at both the subcommittee and full committee levels on insurance matters, several of these dealing with amending or repealing the McCarran Ferguson Act. 
In 2005, the Insurance Competitive Pricing Act ("ICPA") was introduced.  The ICPA did not advance a total repeal of McCarran-Ferguson; it would maintain an exemption from federal antitrust laws for the business of insurance, as regulated by the States, except for price fixing, market allocation, tying arrangements or monopolization. 
The National Insurance Act of 2006  ("NIA") introduced by Senator John Sununu provided for a full repeal of McCarran-Ferguson antitrust immunity, as well as transferring insurance regulation from the states to the federal government.  The approach taken under the NIA is that insurance is an interstate, as well as international, enterprise and state regulation is inefficient and ineffective. 
National insurance companies would lose their antitrust exemption under the McCarran-Ferguson Act except for an important safe harbor. The new exemption would protect:
the development, dissemination, or use of standard insurance policy forms (including standard endorsements, addendums, and policy language), or to activities incidental thereto, by National Insurers, National Agencies, and federally licensed insurance producers. 
In 2009, the Insurance Industry Competition Act (IICA) was also introduced to fully repeal the McCarran-Ferguson Act.  The IICA would repeal the exemption and give the Department of Justice and the Federal Trade Commission the authority to apply the antitrust laws to anticompetitive behavior by insurance companies.  However, the IICA would not affect the ability of each state to regulate insurance.  However, like NICPA and NIA, IICA never made it out of committee hearings and a full vote was not held. 
As of this writingPowrie, Erin2010-08-09T11:52:00
Find out where the health care bill that was passed discussed McCarran-Ferguson., there are three pending measures to modify the antitrust exemption under the McCarran-Ferguson Act.  However, unlike past attempts to repeal or modify McCarran-Ferguson, this legislation is targeted only to health and medical malpractice insurance. 
A full repeal of the McCarran-Ferguson Act is not supported by many, claiming that state law already adequately regulates insurance. As the Iowa insurance commissioner, Susan Voss, testified, "[r]epeal [of McCarran-Ferguson] risks transforming certain insurance practices that help consumers, promote competitiveness, and strengthen markets, into actionable violations of federal antitrust law." 
In addition, many claim that the McCarran-Ferguson exemption allows insurers to share data, which is needed by small insurers, who would be unable to effectively compete.  However, the Antitrust Modernization Commission, which specifically looked into the McCarran-Ferguson Acts exemption, stated that, in the event of a repeal of the immunity, "such data sharing would be assessed by antitrust enforcers." 
Federal Regulation: Creation of National Federal Charter
In addition to eliminating or modifying federal antitrust immunity, a number of broad proposals for some form of national federal charter or other federal regulatory oversight in insurance were introduced in both houses of Congress, but none made it to Committee for further discussion. For example, the NIA introduced in 2006 and 2007 provided for an optional federal charter for insurance, and those insurance companies opting to fall under the federal charter would be regulated by a newly created federal insurance regulatory authority from within the Treasury Department, instead of by the States. 
In addition, the National Insurance Consumer Protection Act (NICPA) was re-introduced in 2009 by Representatives Royce and Bean.  NICPA would establish an Office of National Insurance within the Treasury Department, which would be headed by a National Insurance Commissioner.  While NICPA did not directly address the repeal of the McCarran-Ferguson Act and the re-application of the federal antitrust laws, it required that an insurer provide prior notice to the National Insurance Commissioner to establish or acquire a subsidiary.  However, NICPA never made it out of committee. 
As proposed in NICPA, among others, Congress has considered legislation that would authorize an "optional" federal charter ("OFC"), instead of repealing the McCarran-Ferguson exemption. In addition, in 2008 the Treasury Department issued a Blueprint for a Modernized Financial Regulatory Structure, wherein the Treasury recommended the establishment of a federal insurance regulatory structure to provide for the creation of an OFC.  This OFC would allow insurance companies to choose between the current state-based regulatory system and a single federal regulatory agency. 
The basic design of the OFC that has been proposed is similar to that of the regulatory system that has governed the banking industry.  The benefits of the proposed OFC include efficiency and competitive pricing.  In addition, "creating an OFC would place the insurance industry on the same regulatory footing as other financial industries modernized under the 1999 Gramm-Leach-Bliley Act." 
However, not all parties involved think that federal insurance regulation is appropriate. Therese Vaughn, the CEO of the National Association of Insurance Commissioners has stated "[t]he state-based insurance regulatory system is one of critical checks and balances, where the perils of a single point of failure and omnipotent decision making are eliminated."  Michael McRaith, the Illinois Director of Insurance believes the optional federal charter is "a solution in search of a problem." 
Moreover, the recent financial turmoil among major insurers such as AIG is evidence that perhaps the time has come to reevaluate the creation of a single federal insurance regulator. The proposals advanced thus far have only recommended an optional federal charter.  Given that so many insurance firms, such as AIG, have moved beyond just being insurance companies, that they are now considered "systemically important financial institutions," federal regulatory oversight is necessary. 
When a U.S. corporation is "too big to fail" something is terribly wrong. By the end of 2007, AIG had approximately $1 trillion in consolidated assets and operated in over 130 countries.  The industry giant has more than 71 insurance companies and over 175 other financial services companies.  The 71 insurance companies are monitored by each of the 50 states insurance regulators where it was licensed to operate. 
As such, there is no one insurance regulator or federal regulatory responsible for AIG's insurance activities. Despite its immense global presence, AIG's financial products units were solely regulated by OTS.  As a result of the subprime housing crisis, attention was drawn to both the state and federal regulators and their apparent lack of knowledge of the extent of AIG's involvement.
As discussed in detail above, the exemption from antitrust enforcement within the McCarran-Ferguson Act permitted insurance companies to engage in some anti-competitive behavior.  However, it is clear that times have changed since the law was first enacted in 1945.
When the antitrust laws were first enacted, the biggest threat to our nation's economy was monopolies.  In 1945 when the McCarran-Ferguson Act was enacted, the threat of "boycott, coercion and intimidation" by insurance companies warranted sufficient attention that these three acts were still governed by federal antitrust laws. 
However, today, the biggest concern should be the effect of the failure of any "systemically important financial institutions" on our nation's economy, and how to keep companies from getting so "systemically important" to begin with.  One such "systemically important financial institution" was able to bypass federal antitrust review with its many mergers and acquisitions, by virtue of the McCarran-Ferguson Antitrust Exemption, combined with insufficient state and federal regulatory oversight.
Moreover, for those insurance companies, such as AIG, that have become "too big to fail," a regulatory system that advances a compulsory regulator, or national federal charter, to ensure that any potential failure is eliminated, is imperative. The states have proven ill-equipped to deal with an international enterprise.
When we are told that any corporation is "too big to fail" or that it "cannot go through bankruptcy proceedings because it would devastate our national economy," something needs to change. As Representative Peter DeFazio stated, "AIG was gambling with people's life savings and lost it all too speculative and shady transactions and contributed to the current crisis. We must insure this never happens again."  To do so, it is due time for the McCarran-Ferguson Act to be repealed, for insurance companies to be under full federal antitrust scrutiny, and for a more uniform regulatory system, starting with a national federal charter.