Insurance Anti-rebate Statutes and Dade County Consumer Advocates v. Department of Insurance: Can a 19th Century Idea Protect Modern Consumers?

• Publication year: 1986
• Citation: Vol. 9 No. 03

UNIVERSITY OF PUGET SOUND LAW REVIEWVolume 9, No. 3SPRING 1986

COMMENT

Insurance Anti-Rebate Statutes and Dade County Consumer Advocates v. Department of Insurance: Can a 19th Century Idea Protect Modern Consumers?

John S. Conniff

In 1984, a Florida court of appeals held that the Florida statutes prohibiting insurance agents from rebating part of their commissions to customers violated the due process clause of the Florida Constitution.(fn1) The court concluded that no rational relationship exists between the anti-rebate statutes and the legitimate state purpose of protecting the public.(fn2)

The Florida decision is noteworthy because every state prohibits insurance agents and brokers from rebating to their customers a part of the commission earned from the sale of an insurance policy.(fn3) In addition, every state prohibits unfair discrimination in pricing insurance policies and prohibits agreements between agents and insureds that are not clearly expressed in the insurance policy.(fn4) Collectively, these prohibitions are designed to prevent insurer insolvency and unfair competition.(fn5)

The Florida case highlights a growing controversy over whether these statutes should prevent individual insurance purchasers from negotiating with the agent the price for the services rendered by the agent-the agent's commission. The controversy involves challenges both to the current marketing system of the insurance industry and to fundamental assumptions about consumer protections enacted nearly a century ago. This Comment reviews the history and application of anti-rebate laws, analyzes the arguments presented in the Florida decision, and suggests a transitional approach to ending a system of fixed commissions for insurance agents and brokers.

I. History

Anti-rebate statutes have century-old roots that marked the beginning of the now pervasive state regulation of insurance. The close supervision of insurance companies today is a result of serious abuses in the conduct of the life insurance business in the late 1800s.(fn6)

The rapid growth and cut-throat competition in life insurance markets in the late 1800s created an environment in which greed, theft, and deceit flourished.(fn7) Companies and agents used any means necessary to increase sales and profits.(fn8) To attract sales, agents would split their commissions with some of their policyholders.(fn9) As the practice escalated, companies paid increasingly larger commissions to retain agents and permit agents to offer larger rebates.(fn10) Those companies paying the highest commissions attracted the most agents.(fn11) The more agents a company had, the more a company could increase its market share.(fn12)

Policyholders who did not receive a rebate realized that if an agent could afford to rebate so much, then the policy was not worth as much as was paid.(fn13) Clearly, some policyholders were subsidizing the rebates being paid to other policyholders; thus rebates were condemned as unfairly discriminatory.(fn14)

Policyholders were not the only ones who complained: rebating led to ruinous competition among insurance companies. The practice threatened company solvency and agents' livelihood.(fn15) The cost of obtaining and keeping policyholders increased as agents used their large commissions to offer rebates to policyholders of rival companies in an effort to convince those policyholders to switch companies.(fn16) Agents who could not offer as substantial rebates as competing agents lost customers and thus renewal commissions. As expenses to attract and keep business mounted, agents and companies themselves called for reform.(fn17)

Reform came in 1889. New York became the first state to adopt an "anti-discrimination" statute.(fn18) The statute prohibited rebating by prohibiting discrimination between individuals of the same actuarial class-everyone in the class had to pay the same price for the same policy.(fn19) Three other states adopted similar measures that same year.(fn20) By 1895, twenty-one states had enacted anti-rebate laws.(fn21) Despite the laws, however, rebating continued.(fn22)

In 1895, in response to the ineffectiveness of anti-rebate statutes and under pressure from the National Association of Life Underwriters, thirty insurance companies signed an anti-rebate agreement.(fn23) The agreement provided that the signatory companies would fire any agent found guilty of rebating, and no company would hire the agent for one year.(fn24) By 1899, the agreement had totally collapsed.(fn25) "At more or less regular intervals everyone swore off; rebating was abolished; and then quite to everyone's surprise, there it was still, a dirty but rugged brat, nobody's in particular, not even conceived in sin and iniquity-just a sort of spontaneous conception of the industry."(fn26) In 1906, publicized accounts of insurance company extravagance and mismanagement caused the New York Legislature to create the Armstrong Committee.(fn27) The committee was charged with investigating "the business and affairs of life insurance companies doing business in the State of New York" and recommending statutory changes.(fn28) The findings and recommendations from the Armstrong investigation led to comprehensive revision of state laws regulating insurance, including stricter laws governing insurance agent compensation.

The Armstrong Committee recommended, and the legislature adopted, statutes limiting commission earnings, limiting premium collection charges, prohibiting loans to agents unless proper collateral was obtained, and prohibiting all bonuses, prizes and rewards for new business.(fn29) The committee also recommended strengthening anti-rebate laws. The legislature responded by making illegal not only the giving of a rebate, but also its receipt.(fn30)

In the years immediately following the Armstrong investigation, other states adopted strict insurance laws mirroring those adopted in New York.(fn31) The insurance industry made several attempts to convince the New York Legislature and other legislatures to modify the restrictions on agent commissions but failed.(fn32) For example, in 1908 the New York Legislature passed a bill that liberalized the statute governing agent commissions, but the governor vetoed the changes.(fn33) Eventually, the strict regulation of agent compensation was supported by the insurance industry because of pressure by agents.(fn34)

In 1944, the United States Supreme Court held, in United States v. South-Eastern Underwriters Association,(fn35) that the business of insurance was subject to federal antitrust prohibitions. The Court found that insurance was an interstate transaction and thus could be regulated by Congress.(fn36) Shortly after the case was decided, the insurance industry pressed for congressional action to overturn the decision.(fn37) In response, Congress adopted the McCarran-Ferguson Act,(fn38) exempting the business of insurance from federal antitrust laws to the extent that individual states regulated insurance. In an effort to avoid application of the Robinson-Patman Unfair Trade Act,(fn39) the National Association of Insurance Commissioners (NAIC) developed, and the states subsequently adopted, the Model Unfair Trade Practices Act.(fn40) The Act generally prohibited rebating and specifically defined certain types of prohibited transactions as rebating.(fn41)

Today, every state has an unfair trade practices act patterned after the NAIC Model Act.(fn42) Some states have additional statutes prohibiting rebating, for these statutes in many cases predated the Model Act, and some states have expanded the application of the anti-rebate provisions of the Model Act to all types of insurance.(fn43)

II. The Florida Decision

"We are unable to find any legitimate state interest justifying the continued existence of the anti-rebate statutes."(fn44) With this statement, a Florida court of appeals, in Dade County Consumer Advocates Office v. Department of Insurance, struck down Florida's anti-rebate statutes, which had been adopted in 1915.(fn45) The court held that the statutes violated the Florida Constitution's due process clause by constituting "an unjustified exercise of the police power."(fn46)

The decision in Dade County ended a seven-year legal effort to overcome the anti-rebate laws. In 1977, a licensed Florida insurance agent, Joseph Blumenthal, had sued the Florida Department of Insurance, arguing that the anti-rebate laws prevented him from competing for insurance sales.(fn47) The lower court held that the laws were constitutional, and Mr. Blumenthal appealed to the state supreme court.(fn48) While his appeal was pending, Mr. Blumenthal died, and his case was dismissed as moot.(fn49)

In May of 1983, Walter Dartland, Director of the Dade County Consumer Advocates Office, sued the Florida Department of Insurance, challenging the state anti-rebate statutes.(fn50) Dartland argued that the anti-rebate statutes violated the Florida Constitution "because they unreasonably promote the interests of a limited group of individuals, insurance agents, to the detriment of Mr. Dartland and other Dade County consumers."(fn51) The trial judge, finding no genuine issues of material fact, granted summary judgment to the Department of Insurance.(fn52) The judge ruled that the statutes were a valid exercise of state police power and state regulatory authority in protecting the...