There are two pillars on which ethical principles in insurance rest: the concept of utmost good faith and "affected with a public interest." These have been addressed in two previous articles. To determine what this means for insurance, it's important to look backward in order to look forward.
As stated in Nebbia v. People of the State of New York, 291 U.S. 502 (1934), a governmental action "is unconstitutional only if arbitrary, discriminatory, or demonstrably irrelevant to the policy the legislature is free to adopt." 1 So, in this view, one might infer that the public interest is a matter of procedural due process—how decisions are made. But, under the 5th and 14th Amendments, due process has another side known as substantive due process that introduces standards of reasonableness and fairness—the what element.
Both aspects of the public policymaking process in our democracy were foreshadowed in The Federalist Papers, specifically, James Madison's "Federalist No. 10." 2 In the discussion to follow, I envision the essay as representing a dual message, one addressing a process, the other directed at the ends a new government would pursue.
"Federalist No. 10" is about factions and how to deal with them. Madison defines faction as "a number of citizens, whether amounting to a majority or minority of the whole, who are united and actuated by some common impulse of passion, or of interest, adverse to the rights of other citizens, or to the permanent and aggregate interests of the community." (A "faction" is equivalent to an interest group or pressure group in today's politics.)
For the moment, forget about that "permanent and aggregate interests of the community" part and focus on the group conflict. Madison's view of human nature recognizes that people tend to pursue self-interest and, to preserve and protect that interest, people tend to form factions. "The latent causes of faction" are "sown in the nature of man" and, when nothing of great importance exists to arouse conflicts among factions, he writes, "the most frivolous and fanciful distinctions have been sufficient to kindle their unfriendly passions and excite their most violent conflicts."
Liberty encourages factions. To destroy factions, the new America would have to stamp out the liberty that permits factions, so Madison concentrated on controlling the effects rather than the causes of factional disputes. Protecting the diversity in the faculties of men, which, in turn, leads to factions, Madison saw as the first object of government, so the regulation of "these various and interfering interests forms the principal task of modern legislation."
Scholars later would expand Madison's view of the conflict model role of government as the basis for measuring the public interest. With government as arbiter, consensus could be reached on differences, the two major political parties, as aggregators and expressers of interests, could adapt and thrive in what the late V.O. Key called "dualism in a moving consensus." Ergo, consensus, though not fixed, would define the public interest as the balance of power existing among contending groups at any given time. 3
Viewing the public interest as whatever resulted from the group struggle mirrored the commonly known laissez-faire economic model and eventually morphed into a glorification of "process," a favorite word among advocates of what is labeled the pluralist view of American policy making. As an example after an exhaustive discussion of the public interest, Howard R. Smith came to the following conclusion:
Because in a democracy all declared policies must be tentative only, and because competing policies prior to decision can only be thought of as spurious common goods—THE PUBLIC INTEREST is most properly identified with, not concrete policies as such, but rather a particular kind of process by means of which it is decided what is to be done. 4
Smith's preconditions include freedom of association, a value neutral (not prejudged) mechanism for making policies, resolution of difference over questions of equality and inequality, and a substantive consensus as to the limits at which changes in the status quo will be allowed. His proposed formula for the public interest is that "Consensus + Majority Rule = The Common Good."
Pluralists rarely gave more than lip service to the moralistic ends addressed in Madison's writing, largely explained by the dominant "values free" scientific approach to the study of public policy in vogue at the time. One could hardly follow the empirical nature of scientific methodology and acknowledge a role for a nonquantifiable notion like "the permanent and aggregate interests of the community." This is an interesting oversight because Madison sprinkles terms like "the public good," "the common good," and the "good of the whole" throughout the essay, including, as noted above, his definition of faction.
Pluralists also neglected the context within which Madison was writing. The founders of the American republic were products of Enlightenment thought, especially the writings of John Locke, David Hume, Charles de Montesquieu, and the French philosophers. Far from being a continent inhabited by Robinson Crusoe-type individualists, American colonists, states an alternative view, were not the rugged individualists of this later-developed folklore; rather, they were better described as communitarians and were far more likely to think in terms of what was in the best interests of everyone than most contemporaries can imagine. As some commentators opine, what Madison had in mind was a republic of virtue and Montesquieu's The Spirit of the Laws is suggestive of what he had in mind. 5, 6
In Book V, Montesquieu discusses the principal characteristic of various forms of government. The dominant principle of a republic is virtue, which he defined as "a love of the republic; it is a sensation…." In democracies, "it is love of the democracy" and equality of persons. "The love of equality in a democracy limits ambition to the sole desire, to the sole happiness, of doing greater service to our country than the rest of our fellow citizens." He added, "A love of democracy is likewise that of frugality." Moreover, a republic of virtue valued an informed citizenry, governance by the more enlightened, decisions based upon application of human reason, and rules embodied in covenants, constitutions, and similar documents binding people with each other.
So, taking into consideration this means-ends analysis of Madison's writing, my interpretation is that the new American government envisioned by Madison provided a means of controlling the effects of faction and one resulting end would be a republic of virtue in which the common good (public interest) would be best served. In his words, the new government "provides a medium whose wisdom may discern the true interests of their country" and "the public voice will be more consonant with the public good."
Invoking the public interest as a standard requires holding the interests of the society as a whole above partial interests and a sense of community as opposed to a mere summation of individualistic preferences. The challenge in doing so, he stated in "Federalist No. 57": "The aim of every political constitution is, or ought to be, first to obtain for rulers men who possess most wisdom to discern, and most virtue to pursue, the common good of the society." Further, unlike the formula advocated by Smith, the system of checks and balances, separation of powers, and constitutional provisions did not make majority rule the test of the public interest in every case.
Thus, "Federalist No. 10" is more than just an essay on the regulation of clashing special interests because it also provides a means and ends framework in which conflict is managed and channeled to serve a special end, the common good, or, alternatively, the public interest.
While difficult to quantify, there is still widespread reliance upon acting in the public interest. Restatement (Second) of the Law of Contracts, Section 207, says: "In choosing among the reasonable meanings of a promise or agreement or a term thereof, a meaning that serves the public interest is generally preferred." 7 Likewise, it is common practice that regulatory actions be adopted "in the public interest." Thus, while the meaning may not always be a self-evident truth, policy makers who wish to lift our eyes above the usual fray frequently invoke the public interest as a decision tool. Others observe that public interest is no more difficult to define than "justice," "general welfare," and other everyday terms. Besides, as a higher ideal, even a myth of the public interest serves to raise our vision above narrow self-interest.
That such should be the case ought not be a surprise to insurance professionals who may recall the industry's continuing struggle with meanings of such terms as "occurrence," "resident," "pollutant," "appraisal clause," or "occupying an automobile"; indeed, even the meaning of "insurance" is an unsettled matter subject to changing definitions.
Being affected by the public interest, the insurance industry is important to this discussion because (1) the public sector (government) is an integral part of the industry and (2) insurers serve the basic ends of our nation's common good.
Insurance professionals may sometimes lack appreciation for just how heavily government is interwoven with the industry. Among other things, government decides what constitutes "the business of insurance"; government gives birth to an insurer, monitors its health from that day forward, and handles the insurer's demise, whether it is by absorption into another company, retirement of the charter of incorporation, or through "runoff" of assets and does so to the last economic heartbeat. 8 Most insurance policies require government's stamp of approval—agents selling the policies must be licensed by the state; most claims adjusters need a license to operate; laws control insurer investments, claim practices, and marketing behavior; regulators may approve or disapprove underwriting practices; and the government may conduct examinations that uncover even minor violations of legal requirements that may result in disciplinary action, including fines and remedial activity.
There is much more, including the fact that free market models of our insurance marketplace are inapplicable. From a consumer perspective, whether commercial or personal insurance is involved, purchase of insurance is often mandated, the effect of which is to create a market for insurers. Every state requires minimum limits of liability insurance on automobiles as a condition of driving; lenders require adequate insurance as a condition of a home loan; if a home owner fails to buy homeowners insurance, the lender may place the insurance and bill the home owner for the cost; and the Affordable Care Act, in an effort to provide health insurance for all, initially included penalties for those who fail to buy health insurance. Despite recent removal of this penalty feature by Congress, it is still mandatory that all taxpayers pay for Medicare, a government program that provides medical benefits once a person reaches age 65. Additionally, business owners must purchase workers compensation insurance.
The government-insurance industry relationship is interwoven into the fabric of our social contract. While it is unlikely that the authors of the US Constitution had "insurance" in mind when they included "insure domestic tranquility" in the Preamble, in many ways, the insurance industry aids that objective. Insurance coverage, often described as providing "peace of mind," restores net worth following catastrophes and other financial losses, creates estates through life insurance payments, enables families to survive economic and health-related hardships, and, in doing so, reduces the likelihood that citizens will resort to less peaceful means of achieving the same objectives.
Through the use of credit scoring and other behavior-related factors in underwriting and pricing, insurance incorporates and imposes particular standards of morality in the broader society. In this regard, it serves more than a risk-bearer role by its use of rewards and punishments for particular moral and ethical standards. As risk bearer for economic transactions, insurance furthers innovation, assures economic stability, promotes the general welfare, protects our common defense, lays the foundation for a more perfect union, and, by indemnifying victims of negligent actions, furthers the cause of justice.
Insurers also serve public functions by assisting in the enforcement of laws. Two highly visible examples of this are the statutory requirements to report suspected insurance fraud to regulatory agencies and the industry's longstanding role of assisting in arson investigations. In short, an industry affected with the public interest at heart is also one clothed with an altruistic sense of purpose.
Indeed, the insurance industry's private and public functions sometimes lead it to assume the role of a formal governmental entity. 9 I will address this topic in a later commentary.
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