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Commentary | PERSPECTIVE ON INSURANCE

A Moneyed Octopus Is Out of Control

The Quackenbush scandal points up the impossibility of having states oversee a many-tentacled industry.

May 01, 2000|BERNIE BERNHEIM | Bernie Bernheim is a North Hollywood attorney

The insurance industry is unique compared to other major interstate businesses in one important way: It is not regulated by the federal government. The insurance industry was powerful enough to get immunity from federal oversight through a special act of Congress called the McCarran-Ferguson Act of 1945.

Without this act, the industry would be policed by a federal agency, one probably similar to the Security and Exchange Commission, because an earlier court case had ruled that insurance is a form of interstate commerce.

Think about what multibillion-dollar industries acted like before there was any federal oversight over them. Think about the securities industry during the Roaring '20s, before the crash of 1929 and the subsequent federal legislative reforms of the 1930s. Or, closer to our own history here in California, think about the unregulated railroad industry in the late 19th century.

Students of history will recall that the Southern Pacific Railroad was nicknamed "the octopus"--it had its tentacles in everything that went on in California. It owned much of the land, much of the wealth and even much of the Legislature. It had the raw power that derives from having too much money and too little oversight, and it knew how to use that power to make more money and to hide its activities so there would be even less oversight.

Do the recent revelations regarding how California's Department of Insurance is run suggest that there is a new octopus in the tank?

There is, of course, an industry rationale for why there is no federal oversight of insurance, even though it clearly involves interstate commerce. The theory is that the individual states would be able to better police these multibillion-dollar companies on their own, through insurance commissioners like Chuck Quackenbush in our state.

But this is like saying that we should get rid of the FBI, or that we should not have had the U.S. Marshal Service to help town sheriffs fight the gunslingers. Sure, there were some local sheriffs who could stand up to the bad boys, but a lot of them looked the other way when Jesse James and his gang rode into town. Fortunately, there were federal marshals like Wyatt Earp around.

What the Quackenbush revelations clearly show is that, just like you need more than a local sheriff to police the wild West, you need more than a state insurance commissioner to control the multibillion-dollar insurance industry octopus. Particularly when you consider that State Farm's net worth is equal to the entire annual budget of the state of California--and that's just one of 300 insurance companies that do business here.

The first people to agree that the individual state insurance departments are outmatched, even where they are well-intentioned, are insurance commissioners themselves. Paul A. Roller is a former Alaska state director of insurance, the equivalent to Quackenbush here. As he explains it, "The pressures on the state commissioners of insurance placed on them by the industry are enormous. It takes tremendous energy and character to stand up to it. Generally speaking, the states alone are not up to the task."

The insurance industry itself recognizes that it can easily wrap its tentacles around the little state insurance departments, and around people like Quackenbush. At a 1998 conference of insurance industry professionals, held on the subject of dealing with department of insurance investigations (called "market conduct examinations"), the written materials expressly state that "fines/sanctions imposed by the traditional regulator simply don't compare" with class action lawsuits brought by private, consumer attorneys. The conference outline posed the following question: "Class Actions: The Most Powerful Regulator?"

And, unfortunately, the answer at present is probably yes. Right now, these class action and individual lawsuits are the only "regulators" that have a chance of affecting insurance industry conduct. For example, one insurance group, as reported by The Times, was able to buy its way out of all Department of Insurance regulation on the Northridge earthquake for a mere $1 million. Recently, the same group had to pay $20 million on a single bad-faith earthquake lawsuit.

With the federal government out of the picture, and with weak or co-opted state regulators giving sweetheart deals, only the courts are left to keep this new octopus at bay.

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