State of Idaho Ex Rel. Wayne Soward, Director of Thedepartment of Insurance; State of Idaho, As Liquidator Forpacific Insurance Administrators, Inc., and Pacificinsurance Administrators Agency, Inc., Plaintiffs-appellees, v. United States of America and the Internal Revenue Service,defendants- Appellants, 858 F.2d 445 (9th Cir. 1989)

Thus, federal courts have been reluctant to intrude in state proceedings, adhering to the view that whether it be liquidation or reorganization, the handling of the affairs of insolvent insurance companies is a responsibility retained by the states. See, e.g., Motlow v. Southern Holding & Securities Corp., 95 F.2d 721, 725-26 (8th Cir.), cert. denied, 305 U.S. 609, 59 S. Ct. 68, 83 L. Ed. 388 (1938) (like any other corporation, liquidation of insurance companies is best performed by a single entity possessing title, custody, and control of all assets; vis-a-vis insurers, Congress has left that authority in the states); Levy v. Lewis, 635 F.2d 960, 963-64 (2d Cir. 1980) (quoting Motlow and stating that "the administrative and judicial scheme erected by New York to regulate insurance companies, including that part enabling the institution and implementation of liquidation proceedings, operates pursuant to an express federal policy of noninterference in insurance matters); Universal Marine Ins. Co., Ltd. v. Beacon Ins. Co., 768 F.2d 84, 88 (4th Cir. 1985) ("Reorganization of insolvent insurance companies is a matter of state law and is handled through insolvency proceedings in state court."); Blackhawk Heating & Plumbing Co., Inc. v. Geeslin, 530 F.2d 154, 159 (7th Cir. 1976) ("The states have a paramount interest in seeing that liquidation proceedings conducted by court-appointed liquidators and overseen by their courts are free from [federal] interference.")

Notwithstanding the normally preemptive labyrinth that is the Bankruptcy Code, then, Congress has assigned the States the virtually autonomous role of ministering to their own insolvent insurance companies. Yet that assignment is not a carte blanche for state's to legislate vis-a-vis insurance companies. At all times, States are constrained by the Constitution, particularly with respect to areas of authority conferred on Congress by the People through the Constitution. For example, as a result of the Commerce Clause, Congress has a mandate to enhance the general welfare of the nation by the regulation and promotion of interstate commerce. The assignment of this responsibility to the States is possible, New England Power Co. v. New Hampshire, 455 U.S. 331, 339-40, 102 S. Ct. 1096, 1100-01, 71 L. Ed. 2d 188 (1982) ("It is indeed well settled that Congress may use its powers under the Commerce Clause to ' [confer] upon the States an ability to restrict the flow of interstate commerce that they would not otherwise enjoy,' "), quoting Lewis v. BT Investment Managers, Inc., 447 U.S. 27, 44, 100 S. Ct. 2009, 2020, 64 L. Ed. 2d 702 (1980), but, as in the case of the McCarran-Ferguson Act, such a delegation is to be "narrowly construed in the face of valid federal regulatory interests." Cochran v. Paco Inc., 606 F.2d 460, 467 (5th Cir. 1979); accord United States v. Title Ins. Rating Bureau of Arizona, 700 F.2d 1247, 1249 (9th Cir. 1983) (the McCarran-Ferguson Act "is to be narrowly construed"), cert. denied, 467 U.S. 1240, 104 S. Ct. 3509, 82 L. Ed. 2d 819.

The enforcement of tax obligations pursuant to Article I Sec. 8 of the Constitution represents a similar type of valid and compelling federal regulatory interest that militates against the diminution or supersession of federal authority. The fact that the FIS has been the law of the land for nearly two hundred years testifies to the primacy and constancy of this interest. See Act of March 3, 1797, ch. 20, 1 Stat. 512, 515, Sec. 5 (4th Cong., 2d Sess.), amended by Act of March 2, 1799, ch. 22, 1 Stat. 627, 676, Sec. 65 (5th Cong., 3d Sess.).⁶  For historical background, see United States v. Emory, 314 U.S. 423, 426-28, 62 S. Ct. 317, 319-20, 86 L. Ed. 315 (1941) ("The purpose of this section is 'to secure adequate public revenues to sustain the public burden' [citation omitted], and it is to be construed liberally in order to effectuate that purpose [citation omitted]."). Quite appropriately, then, Congress has explicitly delimited the scope of state prerogatives with respect to the regulation of insurance. In particular, state authority to regulate its insolvent insurers free from preemption by general federal statutes necessarily is qualified by the requirement that the regulation must relate to the "business of insurance."

(E) Construction of the Phrase "Business of Insurance":

(i) The Securities and Exchange Com'n v. National Securities

Case.

The seminal case construing the McCarran-Ferguson Act's phrase, the "business of insurance," is Securities and Exchange Com'n v. National Securities, 393 U.S. 453, 89 S. Ct. 564, 21 L. Ed. 2d 668 (1969). In that case, the Court confronted an Arizona statute aimed at protecting stockholders in insurance companies. A panel of this court had found that the statute superseded the federal securities laws (because it regulated the "business of insurance" within the meaning of the McCarran-Ferguson Act), and hence immunized conduct that was allegedly violative of the anti-fraud provisions of the Securities Exchange Act of 1934.

The key to the Supreme Court's analysis in National Securities was the Court's construction of the term "business of insurance." At the outset, the Court noted that the legislative history "shed [s] little light on the meaning of the words 'business of insurance'." 393 U.S. at 459, 89 S. Ct. at 568. Nevertheless, the Court found it "relatively clear what problems Congress was dealing with." Id. After reviewing the intent of Congress in passing the law, the Court went on to state:

Congress was concerned with the type of state regulation that centers around the contract of insurance, the transaction which Paul v. Virginia [8 Wall. 168, 19 L. Ed. 357 (1869) ] held was not "commerce." 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. Statutes aimed at protecting or regulating this relationship, directly or indirectly, are laws regulating the "business of insurance."

Id. 393 U.S. at 460, 89 S. Ct. at 568.

Applying this reasoning to the statute before it, the Court in National Securities found the Arizona statute outside the scope of the McCarran-Ferguson Act. The Arizona statute did not regulate the "insurance" relationship, but rather the relationship between a stockholder and the company in which the investor held stock. Such a law, said the Court, "is not insurance regulation, but securities regulation." Id. To the objection that the statute applied only to insurance companies, the Court tersely replied that "mere matters of form need not detain us," id., and went on to state:

The crucial point is that here the State has focused its attention on stockholder protection; it is not attempting to secure the interests of those purchasing insurance policies. Such regulation is not within the scope of the McCarran-Ferguson Act.

Id.

(ii) Application of National Securities to this Case:

Application of the holding and reasoning of National Securities to this case leads to the conclusion that Idaho Insurance Code Sec. 41-3342 is not a law regulating the business of insurance. To begin with, the statute deals with insurance companies that no longer are in the business of insurance. The only "business" being conducted is the liquidation of a corporation which happens to have been an insurance company. Hence, the scope of the net cast by the statute is wholly unrelated to the relationship between insurer and insured. The insurer has ceased to exist. The only relationship is between the insureds and the government official charged with overseeing the liquidation of the insolvents. Whereas the Court in National Securities found that in legislating the McCarran-Ferguson Act Congress focused on the relationship between insurer and insured, 393 U.S. at 460, 89 S. Ct. at 568, the Idaho statute speaks to an entirely different concern in this context: the relationship between debtor and creditor. The relationship regulated by Sec. 41-3342 that is at issue in this case is between the liquidated assets of corporations and the claims of various creditors.

Furthermore, only by a great stretch of imagination can it be said that the priority scheme erected by Sec. 41-3342 relates closely to the insurer's status as a "reliable insurer [ ]." National Securities, 393 U.S. at 460, 89 S. Ct. at 568. Once rendered insolvent and placed in the hands of a liquidator, an insurance company no longer is involved in risk protection, nor is there anything that a liquidator could do to make the defunct entity a reliable insurer. In such a situation, the state is no longer regulating the traditional business of insurance, and, thus, has exceeded the boundaries within which the McCarran--Ferguson Act frees it from preemption by general federal statutes. This conclusion is buttressed by the admonition, drawn from the opinion in National Securities, that the exemption "is for the 'business of insurance,' not the 'business of insurers.' " Group Life & Health Ins. Co. v. Royal Drug Co., 440 U.S. 205, 211, 99 S. Ct. 1067, 1073, 59 L. Ed. 2d 261 (1979), citing National Securities, 393 U.S. at 459-60, 89 S. Ct. at 568.

On the basis of the National Securities case, it is tolerably clear that Idaho Insurance Code Sec. 41-3342 is not a law regulating "the business of insurance" within the meaning of the McCarran-Ferguson Act and therefore the statute is superseded by the FIS.

(iii) A Second Level of Analysis:

In assessing the meaning of "business of insurance" within the context of the McCarran-Ferguson Act, the parties devote much attention to two Supreme Court cases decided after National Securities. The first case is Group Life & Health Ins. Co. v. Royal Drug Co., Inc., 440 U.S. 205, 99 S. Ct. 1067, 59 L. Ed. 2d 261 (1979), a dispute involving a price-fixing scheme in Texas between the Blue Shield health plan and pharmacies providing drugs to Blue Shield policyholders. The second case is Union Labor Life Ins. Co. v. Pireno, 458 U.S. 119, 102 S. Ct. 3002, 73 L. Ed. 2d 647 (1982), which involved an insurance company's use of an independent source to evaluate claims made for chiropractic treatments. The relevance of both cases is that in each the Supreme Court used a three-prong test to ascertain the meaning of the phrase "business of insurance."

Although ostensibly appearing to speak to the precise issue raised here, neither Royal Drug nor Pireno are necessary to decide this case. Both cases are refinements of the seminal analysis of National Securities tailored to address activities of insurance companies that would implicate the antitrust laws in the absence of the McCarran-Ferguson Act.

In light of the insurers' insolvency and liquidation, there is no activity of an insurance company to be assessed. The companies have ceased to exist. This is underscored by the parties' omission of discussion regarding the nature of the claims of the general creditors in Class 4. For example, in what capacity did the insurers incur the debts owed to each general creditor? The reason that the parties properly ignore this issue is because the nature of the insurance companies' "activities" is a moot question. Their activities have ceased just as they themselves have ceased to exist--leaving behind a finite pool of assets which the State of Idaho seeks to distribute according to its own plan. This is distinct from any "business of insurance" situation envisioned by the McCarran-Ferguson Act.

The second reason why the two cases need not be reached is that the tripartite analysis developed in Royal Drug and followed in Pireno focused on contracts entered into by insurers directly or indirectly implicating policyholders. Idaho cannot offer a colorable argument to the effect that the general creditors in Class 4 or that the IRS' claims in Class 5 implicate policyholders. By the time these classes of claims are reached, all policyholders' claims will have been satisfied. Even with respect to policyholders in Class 3, their status is most aptly described as "debtors" because the policy relationship has been terminated. Finally, claims in Classes 1 and 2 obviously are unrelated to the insurer-insured relationship. Consequently, this case does not even rise to the level of doubt present in either Royal Drug or Pireno. National Securities and the legislative history alone are enough to decide this case without the three prongs of Royal Drug.

(iv) The Application of the Royal Drug Test:

If we were to examine the facts here in the light of the factors enumerated in Royal Drug, it is clear that Sec. 41-3342 would not pass muster as a law regulating the business of insurance. Royal Drug identified three characteristics of the business of insurance that Congress intended to exempt through the McCarran-Ferguson Act. These characteristics were summarized in Pireno as follows:

[F]irst, whether the practice has the effect of transferring or spreading a policyholder's risk; second, whether the practice is an integral part of the policy relationship between the insurer and the insured; and third, whether the practice is limited to entities within the insurance industry.

458 U.S. at 129, 102 S. Ct. at 3009.

Idaho Insurance Code Sec. 41-3342 does not satisfy any of the tests articulated by the Supreme Court to determine whether a particular practice falls within the ambit of the "business of insurance." The statute's assignment of priority to some creditors as against governmental entities does not transfer or spread policyholder risk. In clarifying the content of the first prong of the Royal Drug test, the Supreme Court has stated that the "spreading" and "underwriting" of policyholder's risk denoted in Royal Drug relates to the "transfer of risk characteristic of insurance." Pireno, 458 U.S. at 130, 102 S. Ct. at 3009. As explained in Pireno, that risk is transferred "by means of the contract between the parties--the insurance policy--and that transfer is complete at the time that the contract is entered." Id.⁷  Consequently, the statute does not speak to "policyholder risk" as defined in Supreme Court jurisprudence.

Nor does the statute play an integral role in the insurer-insured policy relationship for, as stated above, the insurer has ceased to exist by the time this statute comes into play. What the statute does address is the relationship between those left in the lurch by the expiration of the insurer. As among these creditors, the statute purports to establish priorities which relegate government agencies, in particular, taxing authorities, to a subordinated position in terms of the collection of the debt owed by the insured.

Finally, the statute is not limited in effect to entities solely within the insurance industry. Creditors of all varieties have their claims assigned priorities by the statute, including the local, state, and federal governments. Thus, Sec. 41-3342 fails to satisfy even a single prong of the test developed by the Supreme Court to ascertain whether a given practice or contract can be considered to regulate the business of insurance.

The United States Court of Appeals for the Fourth Circuit recently reached this same conclusion with respect to a Maryland statute purporting to assign less than foremost priority to claims of the United States against the estate of an insolvent insurance company. In Gordon v. United States Department of the Treasury, 846 F.2d 272 (4th Cir. 1988) (per curiam), the Fourth Circuit adopted with only modest elaboration the opinion of the district court concluding that none of the Royal Drug factors was met by a Maryland claim-priority statute. See 668 F. Supp. 483, 490-91 (D. Md. 1987); see also Langdeau v. United States, 363 S.W.2d 327, 331 (Tex.Civ.App.1962) ("This is not a regulation of the insurance business; it is a priority established for a class of creditors of an insurance company.") The decision in Gordon simply bolsters our view of this case.

(F) Clarification of Remaining Issues:

This section briefly addresses other objections and points raised by the State of Idaho.

One flaw that ran throughout the State of Idaho's brief and oral argument is its insistence on viewing the statute as a whole. Idaho believes that we should not look only at Sec. 41-3342 to decide the case, but should examine the entire statutory scheme erected by Idaho Insurance Code. There are several problems with this suggestion, the most obvious of which is that it begs the question. When considered as a whole, obviously the statute does seek to regulate the business of insurance; but the question is whether this specific provision constitutes the type of regulation that Congress sought to protect from indirect federal preemption by passing the McCarran-Ferguson Act. If Idaho's approach was correct, the Supreme Court could not have decided National Securities as it did, because the Court would have had to accept the Arizona provision as part of a statute which undeniably regulated the business of insurance.

The second point raised by Idaho is that Royal Drug and Pireno are factually distinct from this case. As indicated above, we agree with this assessment. Both Royal Drug and Pireno dealt with insurance company activities implicating the antitrust laws, whereas this case involves a state statute and a state liquidator acting in contravention of a federal debt statute. Whereas Idaho is correct that the contracts and insurer-insured relationships involved in Royal Drug and Pireno distinguish them from this case, this only serves to underscore the implausibility of the State's position. The point of all three of the aforementioned Supreme Court cases is that the McCarran-Ferguson Act sought to exempt laws which regulate actions of insurance companies involving insurance policies. The insurance contract is truly at center stage. Yet, at base Sec. 41-3342 does not speak to insurance contracts; instead, it instructs a liquidator how to act when distributing the assets of a corporation that once sold insurance.

Finally, Idaho argues that the elements necessary to trigger the application of the FIS are not present. The State's argument is frivolous. The State Director of Insurance filed this interpleader action precisely because the two companies lacked funds sufficient to satisfy their outstanding obligations. This satisfies subpart (a) (1) (B) of the FIS which states that the United States shall be paid first when a person is insolvent and his estate, in the custody of an administrator, is inadequate to satisfy all outstanding debts. In addition, subpart (a) (1) (A) (i) of the statute is satisfied by the companies' stipulation acknowledging insolvency and voluntarily transferring their assets to the Director for purposes of liquidation. The FIS is clearly implicated.

CONCLUSION.

Idaho Insurance Code Sec. 41-3342 is not a law regulating the "business of insurance" within the contemplation of the McCarran-Ferguson Act. Therefore, the Federal Insolvency Statute controls and the United States is entitled to receive full payment of the insolvents' obligations prior to satisfaction of the obligations of other creditors. We reverse the District Court's decision, vacate the judgment, and remand the case for distribution of the remaining assets in a fashion consistent with the FIS, 31 U.S.C. § 3713.

REVERSED AND REMANDED.

EXHIBIT A

Idaho Code Section 41-3342:

41-3342. Priority of distribution.--The priority of distribution of claims from the insurer's estate shall be in accordance with the order in which each class of claims as herein set forth. Every claim in each class shall be paid in full or adequate funds retained for such payment before the members of the next class receive any payment. No subclasses shall be established within any class. The order of distribution of claims shall be:

(1) Class 1. The costs and expenses of administration, including, but not limited to, the following:

(a) The actual and necessary costs of preserving or recovering the assets of the insurer; (b) Compensation for all services rendered in the liquidation; (c) Any necessary filing fees; (d) The fees and mileage payable to witnesses; (e) Reasonable attorney's fees; and (f) The reasonable expenses of a guaranty association or foreign guaranty association in handling claims.

(2) Class 2. Debts due to employees for services performed and benefits accrued to the extent that they do not exceed one thousand dollars ($1,000) and represent payment for services performed within one (1) year before the commencing of delinquency proceedings. Officers and directors shall not be entitled to the benefit of this priority. Such priority shall be in lieu of any other similar priority which may be authorized by law as to wages or compensation of employees.

(3) Class 3. All claims under policies for losses incurred, including third party claims, all claims against the insurer for liability for bodily injury or for injury to or destruction of tangible property which are not under policies, and all claims of a guaranty association or foreign guarantee association. All claims under life and annuity policies, whether for death proceeds, annuity proceeds, or investment values shall be treated as loss claims. That portion of any loss, indemnification for which is provided by other benefits or advantages recovered by the claimant, shall not be included in this class, other than benefits or advantages recovered or recoverable in discharge of familial obligations of support or by way of succession at death or as proceeds of life insurance, or as gratuities. No payment by an employer to his employee shall be treated as a gratuity.

(4) Class 4. Claims under nonassessable policies for unearned premium of [sic.] other premium refunds and claims of general creditors.

(5) Class 5. Claims of the federal or any state or local government. Claims, including those of any governmental body for a penalty or forfeiture, shall be allowed in this class only to the extent of the pecuniary loss sustained from the act, transaction, or proceeding out of which the penalty or forfeiture arose, with reasonable and actual costs occasioned thereby. The remainder of such claims shall be postponed to the class of claims under subsection (8) of this section.

(6) Class 6. Claims filed late or any other claims other than claims under subsections (7) and (8) of this section.

(7) Class 7. Surplus or contribution notes, or similar obligations, and premium refunds on assessable policies. Payments to members of domestic mutual insurance companies shall be limited in accordance with law.

(8) Class 8. The claims of shareholders or other owners.