THE McCARRAN-FERGUSON ACT AND REVERSE PREEMPTION PART III

THE McCARRAN-FERGUSON ACT AND REVERSE PREEMPTION PART III

Part I | Part II | Part IV | Part V

By: Alex Martin

Reverse Preemption and the McCarran-Ferguson Act

As prior discussion suggests, a mechanism for avoiding the preemptive effect of the FAA on state insurance law is found in the McCarran-Ferguson Act, which provides for reverse preemption of federal law by state insurance law in the following manner:

No Act of Congress shall be construed to invalidate, impair or supersede any law enacted by any State for the purpose of regulating the business of insurance . . . unless such Act specifically relates to the business of insurance . . . .[1]

In other words, in a formulaic manner, reverse preemption occurs where:  (1) the federal statute at issue does not specifically relate to the business of insurance; (2) the state law was enacted for the purpose of regulating the business of insurance; and (3) application of the federal statute will invalidate, impair, or supersede the state law.[2]

According to the foregoing test, it appears obvious that state statutes that prohibit or restrict mandatory arbitration in the context of insurance disputes reverse preempt the FAA.  Applying the first prong, the FAA does not specifically relate to the business of insurance—the FAA applies to the enforcement of arbitration agreements generally.  Therefore, any state statute enacted for the purpose of regulating the business of insurance under the second prong, which would be impaired or invalidated by application of the FAA under the third prong, reverse preempts the FAA via the McCarran-Ferguson Act.

Courts across the country have addressed whether a state statute that prohibits or restricts mandatory insurance arbitration was enacted for the purpose of regulating the business of insurance, under the second prong, in one of two ways.  The majority of courts pay close attention to whether the state statute at issue regulates the relationship between a policyholder and his or her insurer.[3]  In SEC v. National Securities, Inc.,[4] the Supreme Court described the insured-insurer relationship as of central importance in defining the business of insurance:

The relationship between insurer and insured, the type of policy which could be issued, its reliability, interpretation, and enforcement—these were the core of the ‘business of insurance.’  Undoubtedly, other activities of insurance companies relate so closely to their status as reliable insurers that they too must be placed in the same class.  But whatever the exact scope of the statutory term, it is clear where the focus was—it was on the relationship between the insurance company and the policyholder.[5]

Other courts, however, have used an alternative test advanced by the Supreme Court in Group Life & Health Insurance Co. v. Royal Drug Co.[6] and Union Labor Life Insurance Co. v. Pireno.[7]  In Group Life and Union Labor, the Supreme Court identified three relevant factors in establishing whether a particular practice is part of the “business of insurance” for purposes of the second prong.  These factors are, none of which are individually determinative:

1. Whether the practice has the effect of transferring or spreading a policyholder’s risk;

2. Whether the practice is an integral part of the policy relationship between the insurer and the insured; and

3. Whether the practice is limited to entities within the insurance industry.[8]

Where a state statute expressly prohibits the enforcement of mandatory arbitration provisions in insurance policies, or restricts the use of arbitration in the context of insurance disputes, the statute appears to regulate the “business of insurance” for purposes of the second prong under each of the above tests.[9]  Moreover, state statutes that prohibit or restrict the arbitration of insurance disputes facially appear to constitute the regulation of insurance.  These state statutes concern an important aspect of the insurance relationship—namely, how disputes are to be resolved—and are directed exclusively at insurance policies.  A handful of courts have specifically held that prohibiting or restricting mandatory arbitration in the context of insurance disputes satisfies the first factor in the Group Life and Union Labor test.[10]  The second factor in the Group Life and Union Labor test, which many courts have placed emphasis on, is plainly satisfied.  The dispute resolution process is a fundamental part of the insured-insurer relationship.[11]

Additionally, the third prong, that the application of the federal statute will invalidate, impair, or supersede the state law, is plainly satisfied.  Enforcement of the FAA in the context of insurance policies where state law prohibits mandatory arbitration of insurance disputes, or restricts the use of arbitration in the context of insurance disputes, would necessarily invalidate or supersede such state statutes.  Therefore, state laws that prohibit or restrict mandatory arbitration in the context of insurance disputes reverse preempt the FAA via the McCarran-Ferguson Act.

The lack of congressional action in this area is telling:  although Congress generally values the enforcement of contracts and arbitration agreements, a state’s choice to prohibit or restrict mandatory arbitration in the context of insurance disputes takes precedence.  If Congress did not possess the foregoing value-hierarchy, it would surely have carved-out the FAA from the McCarran-Ferguson Act’s application at some point.  I was unable to locate any authority that suggests such a carve-out has ever been contemplated.