A Defense of the Insurance Industry Antitrust Exemption?

Josh Wright —  9 February 2010

The subject of antitrust exemptions has been an oft-discussed topic here at TOTM (see, e.g. here and here).  In the latter of those two links I was somewhat critical of the DOJ for taking a neutral stance on the insurance industry exemption, which has now become rather wrapped up in the health care reform debate. I wrote:

Look, when Harry Reid says that he knows insurance companies are anti-competitive “Because they make more money than any other business in America today,” its pretty hard to refrain from criticizing a political ploy that doesn’t have anything to do with the antitrust merits.  Not to mention that Congress is simultaneously considering passing other antitrust exemptions while its striking down others.  I’m sympathetic.  But just to be clear.  Whatever one thinks about the difficulties of application of the antitrust laws to single firm conduct (I’ve certainly been a critic of much of the modern approach to monopolization), it is worth repeating:  cartels are bad.  They raise price.  They reduce output.  That is not what the economy needs.  There is a substantial economic literature on this.  And I don’t think that any economist who has looked at the literature has or would ever support an industry wide antitrust exemption.  If I’m wrong, I’d love to see some citations.  Maybe there is some evidence out there that I’ve not seen that indicates that exemptions improve consumer welfare in practice.  I doubt it.  But that’s what the comments are for.

As the Antitrust Modernization Committee Report and Recommendation says:

Statutory immunities from the antitrust laws should be disfavored. They should be granted rarely, and only where, and for so long as, a clear case has been made that the conduct in question would subject the actors to antitrust liability and is necessary to satisfy a specific societal goal that trumps the benefit of a free market to consumers and the U.S. economy in general.

And:

to extent that insurance companies engage in anticompetitive collusion, however, then they appropriately would be subject to antitrust liability.

To be absolutely clear, I am NOT saying that I believe that repeal of the federal exemption will do much to lower prices or that I believe there is a high incidence of collusive behavior by the insurance firms.   But that’s not the point.  The point is that we should not be defending the merits of exemptions for prohibitions on cartel activity.  Personally, I believe that state imposed barriers to entry, regulatory constraints and rate regulation are more likely a much bigger problem for consumers than anticompetitive behavior and efforts aimed at increasing competition between the states will have a much bigger bang for the buck for consumers.  But the fact that state regulation is also a problem is not a good argument in favor of an antitrust exemption that allows collusion.

The Competitive Enterprise Institute’s Gregory Conko and Kevin Hiferty offer a defense of the exemption (HT: Washington Times):

There is no evidence that McCarran-Ferguson has resulted in higher premiums or profits, however. So, not only is federal intervention unnecessary for ensuring fair competition, it could actually hurt consumers by eliminating practices that help small insurers compete and drive down costs.  The law gives states the primary role in regulating “the business of insurance,” and exempts insurers from most federal regulation, including antitrust laws, as long as the states have laws governing the same conduct.  But where critics see only dominant market power and higher premiums, a closer look reveals a careful balancing by the states that helps promote competition and keep costs in check. As the Congressional Budget Office concluded in October, repealing the exemption would have little or no effect on insurance premiums because “state laws already bar the activities that would be prohibited under federal law if this bill was enacted.”

It is true that a handful of states have highly concentrated markets. In Hawaii, Rhode Island and Alaska, 95 percent or more of the small-group health insurance market is served by just two insurers. But the McCarran-Ferguson Act only shields activities that are integrally related to providing insurance and unique to the insurance industry, and consolidation isn’t one of them.  Practices that are not inherent to underwriting insurance, such as firm mergers, bundling and tying arrangements, agreements to allocate geographic market shares, and many other allegedly anti-competitive activities are, even under current law, subject to federal antitrust enforcement and actively policed by the Federal Trade Commission. So, additional federal intervention would have no effect on insurance industry consolidation.

What would be newly subject to federal enforcement is a variety of ongoing collaborative practices among health and medical-malpractice insurers that are now permitted by the states because they have pro-competitive effects.  At the state level, insurers actively share loss-experience data and related information through rating bureaus, so that each firm has a large enough pool of information to accurately price risks and set aside reserves. In some states, industry-run rating bureaus aggregate this underwriting data and calculate “target” or “advisory” rates under the supervision of state regulatory authorities. Many states also permit insurers to create joint underwriting associations that help insurers pool difficult-to-manage risks and share in the associated profits or losses.

This kind of collaborative activity tends to lower costs, promote insurance industry solvency, and help small insurers compete with bigger firms. Although the Leahy-Whitehouse bill would permit a limited amount of data sharing, the other practices would be subjected to federal antitrust enforcement. That would, ironically, further strengthen the power of the biggest insurers and disadvantage smaller competitors.  Even aside from these important collaborative practices, federal antitrust law would still be a bad fit for the insurance industry. When faced with a market containing two or three dominant firms, a typical antitrust enforcer’s response is to break up the firms into smaller pieces – think of the dissolution of AT&T’s local service monopoly into seven Baby Bells.

But as Boston University health economist Austin Frakt has noted, limiting the size of insurers would also limit their ability to negotiate down prices with health care providers. On the whole, economics research “supports the notion that recent increased market power of insurers does not lead toward monopolistic pricing, but rather it provides a counterbalance to the power held by hospitals and provider groups.”  There are, however, other ways to promote competition in the health insurance market. One change Congress should consider is to permit individuals and business purchasers of health insurance to buy their policies from any willing provider in any U.S. state.  Under current law, an insurance firm registered in one state may not cover individuals in another without registering in the second state and being subject to all of its taxes and laws. This raises the cost of doing business across state lines and prevents many smaller and midsize companies from entering new markets to compete.

Allowing consumers in Alabama, for example, to escape Blue Cross-Blue Shield’s 83 percent market share in that state by shopping for an insurance policy in neighboring Florida’s highly competitive market would increase competition significantly. And it would do so without jeopardizing important pro-competitive business practices that help keep costs in check.  If congressional Democrats genuinely wanted to help consumers, they would seek ways to reduce burdensome regulations on the insurance industry that raise health premiums. Instead, if their effort to “get tough” on the insurance industry succeeds, they would do more harm to consumers than good.

What do readers think?  The economist cited invokes the countervailing power defense argument raised by Steve Salop.  I’m a strong supporter of the idea of opening sales of insurance across state lines as a measure that could help and would not harm.  But that’s not the issue here.   Is there any evidence that lifting antitrust exemptions helps consumers?  I read this article as largely offering the defense that lifting the exemption just won’t matter much.  Are you convinced?

2 responses to A Defense of the Insurance Industry Antitrust Exemption?

  1. 

    Thanks Dom. I appreciate the cite and will give a read.

  2. 

    I’ll admit it’s a bit dated now (although I believe that the arguments are still sound), but I defended that antitrust exemption in “Antitrust and Insurance: Should the McCarran Act be Repealed?”, Cato Journal, Volume 8, Number 3, Winter 1989, pp. 729-749. Since I’m skeptical of antitrust regulation generally, I saw little value (and substantial harm) in having Justice or the FTC attempt to apply “traditional” enforcement to an industry where intercompany cooperation is so important–and so likely to be misunderstood. While supporting the federal exemption, I also called for increased deregulation (of rates, policies, etc) at the state level including the removal “of all legal restrictions that deter competitive entry, rivalry, or cooperation…”

    Dom Armentano
    Vero Beach, Florida 32963