Chapter 1 — Historical Background

The United States Supreme Court has long recognized that insurance is a business coupled with a public trust. Consumers invest substantial sums in insurance coverage in advance, but the value of the insurance lies in the insurer’s ability to fulfill possible future claims. Because the coverage is so important — the ability to provide for dependents in the case of death or injury, to retire, to obtain medical treatment, to replace damaged property — regulation of the industry furthers public welfare.

Insurance regulation in the United States began in the mid-1800s. Several insurance company insolvencies resulted when insurers, who zealously competed for customers, set their rates too low. The hardships consumers endured when their insurance company could not pay claims led to the establishment of state regulatory bodies. In 1851, New Hampshire formed the first state insurance regulatory body, and most other states soon followed suit. In the 1860s, many states passed statutes requiring life insurers to deposit funds with the state and make annual reports concerning their operating condition.

As insurance operations extended across state lines, the industry sought federal regulation to avoid burdensome multiple state regulations. Several New York-based insurers hired Samuel Paul to represent them in Virginia, but refused to deposit the licensing bond required by Virginia law. Paul was subsequently denied a license but sold policies nonetheless, and was convicted of violating Virginia’s statute. The case was eventually appealed to the U.S. Supreme Court, where Paul argued that insurance was a form of interstate commerce subject to federal regulation.

In 1869, the landmark Supreme Court decision in Paul v. Virginia precluded federal regulation of insurance. The Court held that insurance is a local transaction — not a matter of interstate commerce — giving states the clear authority to oversee the insurance industry. Subsequent efforts by the industry to amend the U.S. Constitution to permit federal regulation also failed.

In 1871, the New York superintendent of insurance convened insurance commissioners from the other states. This group, known today as the National Association of Insurance Commissioners (NAIC), was formed with the purpose of enacting uniform legislation in each of the states. It continues to promote uniformity among state insurance legislation and argue for continued individual state regulation.

The NAIC has increasingly taken on what one Insurance Commissioner called a “quasi-regulatory role” — albeit with no enforcement ability or governmental oversight. Over the years, states and the federal government have relied on the NAIC to coordinate insurance regulation across the country.

In 1905, a New York legislative investigating committee scrutinized the U.S. insurance industry. The Armstrong Commission revealed questionable, unethical, and illegal practices by some companies, and recommended reforms that prompted the passage of new regulatory legislation throughout the country — including state-mandated non-forfeiture options for cash value life insurance policies. These reforms strengthened public confidence in the insurance industry.

In 1944, the U.S. Supreme Court ruled in U.S. v. South-Eastern Underwriters Association (SEUA) that the business of insurance was interstate commerce and subject to federal regulation. This called into question the entire system of state regulation — and the ability of the states to collect premium taxes.

In response, Congress passed the McCarran-Ferguson Act (1945), which declared that the continued regulation and taxation of insurance by the states is in the public interest, and that no federal law would apply to the business of insurance unless it specifically said so. The Act also exempts the business of insurance from federal antitrust laws to the extent it is regulated by state law. As a result, all states enacted Unfair Trade Practices laws which outlaw boycotts, coercion, and intimidation.

In 1974, Congress enacted the Employee Retirement Income Security Act (ERISA) to govern private-sector pension plans and employee benefit programs such as HMOs. ERISA imposes certain requirements on persons offering employee benefits, but does not override state insurance laws that may apply to these plans.

Congress amended ERISA in 1983 to more clearly spell out continued application of state insurance laws over “ERISA plans” — including licensing of entities selling health care benefits. Unfortunately, the language of that amendment was written as an “exemption” to a “preemption” — in effect a double negative — creating more confusion than it solved. For decades, operators continued to dodge state licensure by claiming an exemption as an “ERISA plan.”

The Financial Services Modernization Act of 1999 (also called Gramm-Leach-Bliley) overturned the Glass-Steagall Act, allowing banks, securities firms, and insurance companies to merge and offer integrated financial services. The federal government retained primary jurisdiction over banking and securities; the states were left in control of insurance, but subject to federally mandated uniformity requirements — particularly agent licensing reciprocity.

Two Supreme Court rulings prior to 1999 further opened insurance and annuity markets to banks: Barnett Bank v. Nelson (overturning a Florida law prohibiting bank insurance sales) and NationsBank v. VALIC (allowing national banks to sell variable annuities). As a result, banks may now offer all types of insurance products.

This fragmented regulatory system — with varying laws from state to state and limited federal jurisdiction — creates an environment that can be exploited by dishonest promoters of unlicensed insurance products. In 2002, as a response to a wave of unlicensed entities marketing health care benefits in Florida, the Florida Legislature increased the penalties for companies and agents who sell phony insurance, and required all Florida-licensed agents to complete 3 credits of continuing education related to unlicensed entities. That is the purpose of this course.