With the enactment of the McCarran Act, Congress confirmed the principle of retaining state insurance regulation, and it declared that the federal antitrust laws should apply to the business of insurance only to the extent that the business is not regulated by state law. The actual scope of the McCarran antitrust exemption depends on judicial interpretation of three key elements in the Act: (1) the "business of insurance," (2) "regulated by State law," and (3) boycotts.

Business of Insurance. If the activities under consideration do not constitute the "business of insurance," even if performed by an insurer or an insurance agent, they are not protected by the McCarran Act. Not only are such activities subject to antitrust laws but they are also subject to any relevant federal law (even though not specifically relating to insurance). Thus the scope that the courts give to the business of insurance is crucial to the vitality of the McCarran Act.

Following the enactment of the McCarran Act, most people believed that the statutory language, "business of insurance," offered a broad umbrella. Despite a boycott provision in the McCarran Act and the fact that variable annuities had been found to wander off the insurance reservation, these situations were rare exceptions, rather than the rule. Early unsuccessful challenges vindicated this perception. Consequently, the McCarran Act comfort index was quite high.

However, in 1979 the Supreme Court dropped a bombshell in Group Life & Health Co. v. Royal Drug, with an aftershock 3 years later in Union Labor Life Insurance Co. v. Pireno. Both cases involved arrangements by a health insurer with health care providers in efforts to reduce the cost of health insurance. The availability of the McCarran Act defense against these antitrust actions turned upon whether the insurers� contracts with the health providers constituted the business of insurance. In finding that they did not, the Court asked three questions to determine whether a given activity or conduct is the business of insurance: (1) Does such activity or conduct have the effect of transferring or spreading policyowner risk? (2) Does the activity or conduct constitute an integral part of the relationship between the insurer and the insured? (3) Is the activity or conduct limited to entities within the insurance industry?

With these decisions, the Supreme Court cast a pall over those in the insurance industry and regulatory communities relying on the McCarran Act exemption. The first criterion�transferring and spreading policyowner risk, a concept that is subject to significant stretching or technical narrowing as the mood strikes the Court�is particularly troublesome. An affirmative finding of all three elements clearly establishes the conduct as a part of the business of insurance. However, an unresolved issue is whether every one of these three criteria must be met before the McCarran protection is available or whether each is a factor to weigh in arriving at a decision. If all three are required, the scope of the McCarran exception would appear to have been severely circumscribed.

Regulated by State Law. Even if the activities under consideration constitute the business of insurance, to the extent that they are not "regulated by state law," they lose their McCarran antitrust immunity. The Supreme Court standard is that insurance legislation that proscribes conduct and authorizes enforcement through a scheme of administrative supervision that is not a mere pretense satisfies the regulated-by-state-law requirement of the McCarran Act. With subsequent lower court elaboration, the prevailing articulation of the standard became whether state law "proscribes, permits or authorizes" the challenged conduct. As long as there is a statute or regulation covering the general area under consideration that is capable of being enforced, or as long as the regulatory scheme is comprehensively and meaningfully administered, it need not address every detail of the business of insurance.

However, to meet the McCarran standard, the state law must be an insurance regulation, as distinguished from general law that only incidentally applies to the insurance industry. That is, the regulation needs to be aimed directly or indirectly at protecting or regulating the policyowner-insurer relationship. The law also needs to be the law of the state in which the challenged activity is practiced and has its impact.

The argument has been advanced, both in a judicial context and by critics of state insurance regulation, that the regulated-by-state-law standard should be met only if state regulation is "effective." Adopting that test would place the courts in the role of overseer of the effectiveness of state law, heretofore the function of Congress. Whether over time the Supreme Court will continue to avoid giving the test its judicial approval is not certain.

Boycott. To successfully raise the McCarran Act defense against an antitrust challenge, the activity cannot constitute a boycott. In general, a boycott can be defined as a group or concerted refusal to deal. This refers to a method of pressuring a target party with whom one has a dispute by withholding and getting others to withhold patronage or services from the target. If the term boycott, as used in the McCarran Act, is defined broadly, it could very well emasculate the McCarran antitrust exemption.

Because of the history of the boycott provision�s origin in the McCarran Act, one line of lower court cases found that the term boycott, as used in the act, was limited to protecting only insurers and agents from the type of activities that arose in the South-Eastern Underwriters case. However, the Supreme Court disagreed in St. Paul Fire & Marine Insurance Co. v. Barry, when it held that the term boycott should be interpreted in the tradition of the antitrust laws, which includes concerted refusals to deal with customers who are the ultimate target of the boycotters.

Although Barry found that an absolute refusal to deal on any terms constituted a boycott within the meaning of the McCarran Act, there are also conditional refusals to deal (refusals to deal except on certain terms). Many practices condemned by the antitrust law can be seen as conditional refusals to deal. For example, an allegation of price fixing can be viewed as a refusal to deal except at the price agreed upon; assuming insurers develop and utilize an agreed-upon policy form, a plaintiff can simply allege a refusal to deal except on the insurers� terms as to the content of the policy. Barry neither decided nor gave clear signals as to whether a conditional refusal to deal gives rise to a boycott. If such conditional refusals to deal are deemed to be boycotts, the term has become so broad in the context of insurance company activities that the McCarran Act antitrust exemption could become a virtual nullity.

Over the past 30 years, insurance regulatory reform initiatives have been proposed by presidential commissions, various federal regulatory and administrative agencies, the Department of Justice, the General Accounting Office, and both houses of Congress. Most have recommended that the McCarran Act be either amended or repealed. In the 1980s and early 1990s numerous bills were introduced in Congress to alter the status of the McCarran Act. They ranged from a total repeal of the act to more limited versions that would repeal the proviso clause that gives rise to the antitrust exemption. Some would alter the proviso to apply the antitrust laws in general to the insurance business but at the same time provide "safe harbors" for specified collective activities of insurers. Another would affirm continued state insurance regulation by retaining the antitrust exemption but would redirect certain activities currently under state control to regulation under federal antitrust law. And more important, several bills would directly or indirectly vest authority in the FTC over unfair and deceptive trade practices. Although to date the McCarran Act has proven resistant to change or repeal, the persistency and intensity of efforts to do so may ultimately result in congressional changes that have far-reaching implications for insurers, agents, regulators, and insurance consumers.

In short, the scope of the McCarran Act antitrust exemption has been significantly eroded by judicial interpretation of the "business of insurance," "regulated by State law," and "boycott" standards in the act. Whether the judicial narrowing will continue, reverse, or stabilize is yet to be determined. Although even under the narrower exemption, many antitrust challenges have been rebuffed by the courts, several have not. Clearly, the door has been opened to applying antitrust law to the insurance business. Future judicial decisions and Congress may push the door open wider.

Since the insurance industry, agents, and regulators may have to function within an antitrust environment even more in the future, a basic awareness of the antitrust laws is essential to a better understanding of the regulation of insurance.

Federal antitrust law consists of four statutes: the Sherman, Clayton, Robinson-Patman, and FTC Acts. However, since the legal standards in these laws are couched in very broad language, judicial interpretation in the context of a multitude of fact situations gives antitrust law its real substance and content.

The Clayton Act prohibits certain types of conduct, such as tying, exclusive dealing arrangements, interlocking directorates, and mergers that may substantially lessen competition or tend to create a monopoly. The Robinson-Patman Act, an amendment to the Clayton Act, focuses on unfair price discrimination. Since these two acts, to a significant extent, relate to commodities, much of what they contain may not be directly applicable to insurance. However, the provisions relating to acquisitions and mergers and interlocking boards have been applied.

The FTC Act prohibits unfair trade methods of competition and unfair and deceptive practices. The Supreme Court has made it clear that the activities that violate the Sherman or Clayton Acts also violate the FTC Act. Consequently, this act is both an unfair trade practices and an antitrust law. It renders the FTC a major antitrust player.

The Sherman Act is the oldest and the heart of the antitrust law. Sec. 1 states that every contract, combination, or conspiracy in restraint of trade is illegal. There are two major elements in a Sec. 1 offense. First, there must be either explicit or implicit action; unilateral action is not proscribed. Second, the challenged conduct must be a restraint of trade. However, the Supreme Court has ruled that only unreasonable restraints violate Sec. 1.

In the context of the insurance business, less attention has been focused on Sec. 2 of the Sherman Act, which deals with various types of activity relating to monopolization. Monopoly power is "the power to control market prices or exclude competition." Under antitrust law, the meaning of monopoly has not been confined to the pure monopoly (one firm seller) but also embraces firms that are dominant in the market�that is, firms that have a high degree of monopoly power. Monopoly is defined in terms of a given product and geographic market. If the court finds that the relevant market in a given insurance situation is a line of insurance in a given state�a not unlikely result�there may be several markets around the country that are highly concentrated (a few sellers writing a high percentage of the business). Such circumstances create potential antitrust offenses or at least allegations of monopolization. The combination of monopoly power and predatory pricing (prices set below costs to drive competitors out of the market) is a likely candidate for a Sec. 2 offense. Thus Sec. 2 assumes a greater role in the insurance arena than some might realize.

The Department of Justice and the FTC, as the antitrust enforcement agencies, may bring civil actions for injunctive relief to restrain or prevent violations of both the Sherman and the Clayton Acts. The FTC has exclusive authority to enforce Sec. 5 of the FTC Act. The FTC functions through administrative hearings and, if it finds a violation, it can issue cease-and-desist orders. Conduct violating the Sherman Act can be subject to criminal actions. Corporate defendant violations are punishable by fines; individuals, including corporate officers, can be fined and/or imprisoned. Private parties also can bring actions for treble damages under the Sherman and Clayton Acts.

The state action doctrine might provide antitrust immunity in addition to that available under the McCarran Act. In Parker v. Brown, the Supreme Court presumed that Congress did not intend the Sherman Act to nullify a state�s control over its officials. That act prohibits private action, not state action.

The crucial issue is what constitutes state action; more specifically, to what extent does action of private parties, such as insurers or agents, taken within the framework of state legislative policy and regulatory enforcement constitute state action? In 1980 the Court adopted a two-prong test to determine whether the challenged activity of a private party constitutes state action that makes it exempt from the federal antitrust laws. First, the challenged conduct must be a restraint on competition that is "clearly articulated and affirmatively expressed as state policy." A state policy that permits, even though it does not compel, anticompetitive conduct can qualify as state action as long as the state clearly articulates its intent to adopt a permissive policy. Second, the articulated state policy to displace competition must be actively supervised by the state. Passive acceptance of private action is not enough.

Although the state action and the McCarran Act antitrust immunities overlap, they are not the same. The formulations of the basic principles governing the scope of the two exemptions (the state action�s articulated policy and the McCarran Act�s "business of insurance") and the regulation requirement (the state action�s active supervision and the McCarran Act�s "regulated by state law") are different. The application of different principles to the same fact situations often yields different results. Thus the availability of the McCarran Act exemption might afford antitrust immunity in situations where the state action doctrine would not and vice versa.

General application of antitrust law to the insurance business could proscribe a wide variety of activities and practices heretofore deemed appropriate and beneficial. Furthermore, other activities, even though they may not ultimately be found to be a violation of antitrust law, might be deterred because of the threat of lengthy, time-consuming, and costly litigation that could result in very large treble-damage judgments.

Application of the Substantive Content of Antitrust Law. Although evaluating the seemingly infinite number of ways antitrust law could challenge industry conduct is beyond the scope of this chapter, a few illustrations will highlight the problem. While property and liability insurers appear most vulnerable to antitrust challenge, life insurers and their agents are not immune.

Pricing. Price fixing is one of the major focuses of antitrust law. Property and liability insurers, with their long history of collective rate making through rating bureaus, are particularly vulnerable to antitrust challenge. However, pricing activity problems can also emerge outside the rating bureau context on the life insurance side of the business.

For example, an insurer who has captured a significant share of a market (which might be defined as a particular type of insurance policy in a state or even smaller geographical area) and competes with low prices, might be the subject of an antitrust suit by a disgruntled competitor alleging monopolization through predatory pricing. There is a very indistinct line between competitive prices and predatory prices, especially with respect to life insurance, where the actual cost of the product is not known until some time in the future. Furthermore, since life insurers differ from most other business organizations in that they do not know the true cost of their products until years after they are sold, gathering and sharing information collectively is essential to reasonably predict future costs. Nevertheless, sharing or exchanging current or projected prices or other rate-making information could be highly susceptible to charges of price fixing.

Policy Forms. There is a lot of room for uncertainty about the legality under antitrust laws of insurers� collective work on policy form development even though it is often encouraged by state regulatory practices and conducted within the framework of state regulatory policy approval standards and mechanisms. For example, competitors� joint efforts to exclude coverages on standardized policy forms can be viewed as concerted refusals to deal�that is, boycotts.

Selling Practices. Selling practices by both insurers and agents�conditioning the sale of a health insurance policy on the purchase of a life insurance policy or tying the sale of a life insurance policy to a waiver-of-premium disability rider�might constitute per se violations. Antitrust actions have also been brought alleging illegal tying when the availability of group insurance is conditioned on being a member of a group, even though being a member of a group is a fundamental group underwriting concept. Furthermore, a widespread failure to engage in rebating might be susceptible to an antitrust challenge as a conspiracy that creates an unreasonable restraint of trade. Insurers also need to be aware that imposing certain restrictions on agents� rebating or other agent business practices or activities (such as territorial or customer restrictions) could result in vertical restraint issues.

Pooling. State policy includes maximizing the availability of insurance to those needing coverage. Among the techniques used are sanctioning various voluntary pooling arrangements and mandatory residual market mechanisms. The insurance industry is replete with voluntary pools to serve a wide variety of needs (providing markets for extraordinarily large coverages or particularly risky businesses, for example, or enabling small insurers to combine in a way that makes them better able to compete with their larger brethren). In order to function, participants in pools use common classifications, rates, and policy forms, and they engage in other joint activity. Because the activities are in concert, pooling could run afoul of antitrust laws. Although antitrust laws include a number of provisions defining permissible and impermissible joint ventures, most likely some insurance pools would be prohibited and the legality of others determined only after lengthy and complex litigation involving the application of the rule of reason.

Chilling Effect of Potential Litigation. The pervasive uncertainty about how antitrust principles will be applied in different insurance contexts chills not only the ardor of the more aggressive competitors but also the willingness of many insurers to participate in collective mechanisms to serve various public policy objectives. The threat of litigation is real. Antitrust law permits, even encourages, such actions by providing for treble damages. Private parties have not been reluctant to bring antitrust actions to deter an overly vigorous competitor or to obstruct efforts to control costs, such as those relating to automobile and health insurance. It is also not unknown for treble damage litigation to be used for commercial shakedowns. The possibility of treble damages, the creativity of plaintiff antitrust lawyers, the potential of large and hugely expensive class action litigation, the civil and criminal penalties available to the government, and the uncertain results when applying antitrust law to insurance all tend to stifle even activity that might ultimately pass antitrust muster. Thus the threat of litigation promises to render insurers less willing to act in a creative and flexible manner in conducting their insurance operations and competing in the insurance markets. For the most part, insurers� activities are rooted in sound and legitimate insurance purposes, but the application of antitrust law might very well deter, if not actually prohibit, the achievement of those purposes. The application of antitrust law would impose a wholly new and not necessarily beneficial form of regulation on the insurance industry. The state action doctrine might provide some relief, but it does not promise to provide an adequate substitute for a viable McCarran Act exemption. Moreover, dependence on the state action doctrine would constrict the range of options available to the states in responding to regulatory problems if they feel compelled to opt for more stringent anticompetitive approaches to ensure successful invocation of the state action exemption.

If and when the antitrust laws become generally applicable to the insurance business, either because of judicial or congressional narrowing of the McCarran Act antitrust exemption or the elimination of the exemption, it will not only have a direct impact on insurers, as illustrated above, but it will also change the insurance regulatory structure dramatically.

Judicial Preemption. To the extent the McCarran antitrust exemption becomes inapplicable, thereby resulting in a general application of antitrust law to the insurance business, the preemption doctrine comes into play. As discussed earlier, whether a state law or regulation survives is determined by the Supreme Court�s two-test approach in evaluating whether a particular state law or regulation should be preempted: the congressional intent test and the conflict test. Although in specific instances under the preemption doctrine, antitrust law may override conduct carried out under state insurance regulation, based on recent cases and a generally more conservative Court, it does not appear that the Supreme Court would be inclined to apply antitrust law in a manner that would achieve a wholesale preemption of the state insurance regulation. Consequently, if the insurance antitrust exemption is narrowed or repealed, the application of the preemption doctrine promises to result in full-scale dual regulation that the courts will try to accommodate as best they can. Under this likely scenario, insurers, agents, and buyers will need to thread their way through two different sets of regulatory requirements (state insurance regulation and federal antitrust law) enforced by two very different sets of mechanisms, people, and philosophy.

FTC Involvement as a Regulator. The narrowing or repeal of the McCarran insurance antitrust exemption also gives rise to the specter of substantial regulatory, as distinguished from antitrust, control by the FTC.